The decision to exercise your stock options is a challenging one. When you’re considering exercising your options,
there are six factors you should consider beforehand.
1. Do your shares have value?
The first aspect to consider is whether your shares will have any value when you exercise and in the future.
You might be receiving a discount on the shares, but you’re still paying out of pocket to purchase them.
If share prices drop or the company isn’t as successful as hoped, you might end up with worthless shares.
Some questions you can ask yourself about share value are:
Is the company doing well financially? Some signs of financial distress are low cash flow,
budget cuts without redirecting the funds to other projects, and more debt than is typical for the
industry the company is in (the company might be over-leveraged).
Are the share prices still increasing, and is there a decent amount of trading volume?
If share prices are falling, it may mean investors have lost confidence in the company.
If investors are not actively trading shares, they are holding them either because they have value
or because no other investors will buy them.
Is the company developing new products or services and remaining competitive?
If not, time in the market may be limited.
Are professional analysts predicting longevity or a short-lived stint on the market?
Many investors listen to stock analysts and base their decisions on their outlooks,
causing the investors to fulfill their own prophecies about a company’s future. It helps to
find out what the “experts” are saying.
Is the stock’s market value too high or low?
Investors can ramp up a stock’s price out of irrational exuberance. Considering what you know
about the company, determine if the stock’s market price is justified.
2. Is the company private or public?
Whether the company is private or public has a significant impact on the number of investors
that it can reach. Public companies are often safer investments because they are monitored and regulated.
Private companies are not, so it is much more difficult to determine if they are good investments.
However, if the company is going public soon, it is a good indication that shares will increase in
value—at least for a while.
3. When are you fully vested?
You should make sure you understand when you’ll be eligible to exercise your options or if you can
exercise early. Vesting periods and exercise expirations can range from a few years to a decade or more.
When you close in on your eligibility period, you’ll also only have a specific amount of time to exercise
the options. Knowing this in advance can help you plan for the right time to buy your stock.
4. How much investable capital do you have?
When you exercise your options, you should determine how much you should invest based on your
financial circumstances. It pays to be cautious when you’re considering buying the stock of a
company you work for because it is easy to become biased.
A good rule of thumb when investing is never to invest more than you can afford to lose.
If you need to dip into your emergency funds, withdraw from your retirement account, or use your
home’s equity to exercise, it might not be worth it. However, it may be a beneficial purchase if
you use money that isn’t set aside for anything else.
5. How diverse is your portfolio?
When you’re considering exercising, it helps to ensure the purchase doesn’t tinker with your
portfolio’s diversity. For example, if you work for a tech company and already own stocks from
the company’s competitors, you might consider reallocating some assets when you exercise your
options to maintain your balance.
6. What are the tax implications?
The number one consideration for deciding when to exercise is how it affects your taxes.
As discussed previously, how you are taxed depends on what you do with your shares, how much you make,
and the type of options you have.
Take the time to consider what the tax implications of exercising and selling your shares will be.
For example, if you have a non-qualifying stock option and exercise it, you might be bumped up a
tax bracket, have to pay taxes on the gains, and trigger alternative minimum taxes all in the same year.
You may wish to speak with a tax professional if you have questions on how taxes may impact you.
Should you exercise your options early?
Exercising your options early is a choice some employers give their employees in the options grant.
You can pay for your shares at the discount price with an early exercise, but you don’t own them until
you meet the vesting criteria.
There are some advantages to exercising early. On average, you decrease the taxes you owe by 13% (depending on the state),
but you’ll still need to keep the shares for at least two years after the grant date and one year after you exercise.
If you exercise early, you start the holding period sooner, and you’re also less likely to owe additional taxes.
There are a few disadvantages to exercising early, too. You’ll have to use your own money to purchase the shares,
and you’ll have no idea whether they will increase in value. Another potential downside is that you won’t be able
to exercise more than $100,000 per year, even if you have the means to do so. Lastly, you stand to lose a lot of
money if you don’t understand how and when to exercise your options—remember Cris? But for the time machine,
she would have lost the opportunity to gain an extra $500,000 by waiting to exercise her options.
Pre-IPO financing may give you choices
If your options grant states that you can exercise early, then it may make sense to do so if it
fits your circumstances. However, not everyone has the means to exercise early—and that’s where Quid can help.
Stock option financing from Quid gives you the funds to start the capital gains clock early by activating your
holding period sooner—this acts to lower your taxable event when you eventually sell your shares.
If you have options to exercise and your company is working on an IPO (or even if they’re not and you have questions),
then request a free consultation and learn how Quid can help you get the most out of your pre-IPO shares.