For startup employees, choosing to exercise stock options can be a big decision. It requires taking into account a host of factors including the company’s probability of an exit and personal circumstances. While exercising after an exit can help to cover costs, it can also lead to higher taxes. That’s why many startup veterans choose to exercise their options before a company goes public.
While this may seem complicated, exercising options is often simpler than it sounds. There are also several ways to finance the expense if you choose to exercise before an IPO. Below, we break down what they are and how to decide which one is right for you.
Borrowing From Friends and Family
A common way to finance the purchase of shares is by borrowing funds from friends and family. Depending on your equity package and the number of people you decide to borrow from, this could be a viable option, especially if you choose to exercise only a portion of your shares.
If your equity package is more substantial, or you’re worried about burdening loved ones with the expense, other financing options may be more appealing.
Taking Out a Personal Loan
Another popular form of financing is a personal loan. This can be a good option if you’d like to borrow a larger amount of money and if you’re comfortable committing to a monthly repayment schedule.
However, it’s worth noting that the interest paid on personal loans can make exercising your options much more expensive. According to Experian, the average interest rate of a personal loan is 9.41%. This means that you’ll be paying a premium to finance the purchase of your shares and inflating your costs in the process.
It’s also important to keep in mind that personal loan payments begin as soon as the loan is funded. If your company doesn’t have an exit soon after you exercise your options, you may need to pay back the loan without being able to unlock the value of your shares. The same is true if the company never exits—you’ll be responsible for the full loan amount, plus interest.
Selling a Portion of Your Shares on a Secondary Market
If you’re hoping to cover your costs without having to borrow money, selling some of your shares on a secondary market can help you get the funds you need. This can be especially helpful if you don’t mind liquidating some of your shares, and if you prefer to pay for your shares upfront.
However, it’s important to keep in mind that selling shares may lower your payout if and when the company goes public. Depending on the company’s exit value, this could mean losing out on substantial gains down the road. Selling your shares also carries a substantial tax burden. The portion of shares you sell will be taxed at the highest possible tax rate.
Another possibility is non-recourse financing. Designed to minimize costs and help you maximize the value of your shares, this type of financing doesn’t require upfront payment, and your equity is the only collateral. Payment is only due if your company gets acquired or goes public.
If you’re interested in non-recourse financing, working with a company that specializes in startups can make a big difference. As a leading expert in startup equity, Secfi makes it easy to finance the purchase of your shares and can complete financing in as little as three business days.
You’ll also have access to tools like the Exercise Tax Calculator which can help you gain insights into your potential payout. Best of all, if your company doesn’t have an exit, there’s no need to repay. Secfi will accept the loss without any added costs.
Although tapping into startup equity can be exciting, it can also feel overwhelming. Thankfully, there are a variety of options available to help you minimize costs and maximize returns. By weighing your choices carefully, you’ll be able to exercise your options without the need to pay out of pocket.