Equity is a great perk of working for a startup, but employees are often confused about the best way to maximize the equity they’re given.
If you’re a startup employee who wants to make the most of their stock options, gaining a better understanding of your equity package can help. Here are some things to keep in mind when determining how to unlock the value of your options.
Understand Your Vesting Schedule
One of the key things to understand when it comes to equity is that it takes time for your options to vest. The typical vesting schedule for most startups is four years, including a one-year cliff.
Simply put, if you choose to leave the company within the first year, you won’t receive any equity at all. After the first year, you’ll receive 25% of your options and a smaller percentage every month thereafter. If you stay with the company for four years, your options will be fully vested.
It’s also important to note that if you choose to leave the company after some or all of your shares have vested, you’ll generally have a 90-day period where you can exercise those options. Depending on your package, even 25% of your shares can add up to a significant amount of equity.
Consider Your Company’s Exit Strategy
Another important thing to keep in mind is your company’s exit strategy. If it appears to be headed toward an IPO, you may want to have a plan in place for exercising your options. The same is true for an acquisition.
Your overall optimism about the company’s future is also important. Even without the immediate prospect of going public, you probably have some sense of how successful the company is likely to be. If you feel that there's a strong chance of an exit, we recommend deciding when and how you want to exercise your options.
Think Carefully About Timing
Perhaps the most crucial factor when it comes to equity decisions is timing. Choosing to exercise options after an exit is often the simplest way to cover costs and manage tax liabilities, but it can also come with downsides.
One of those downsides is that it's often more expensive to exercise stock options as companies grow and prepare for an exit. This is due to the fact that taxes become higher as the 409A valuation of a company increases. Once a company goes public, taxes are calculated based on the share price of the company’s stock rather than on the previous valuation. The result is a much higher tax bill.
Another downside is the impact on your long-term capital gains tax rate. This is because tax laws tend to favor stocks that are owned for longer than 12 months. If you decide to exercise your options before your company goes public, you will be taxed no more than 20% when you sell your shares. If you decide to wait until your company has an exit, that tax rate can go up to around 37%.1
The third potential downside has to do with the value of your shares. Because the price of your shares will fluctuate once the company goes public, knowing when to sell can be a bit of a guessing game. Reaching the long-term capital gains window before the IPO will allow you to sell your shares whenever is best for you.
If you decide you’re ready to exercise your options, having the right guidance can make a big difference. The equity experts at Secfi can help you make sense of your particular situation and provide you with resources designed to help you project your payout and your tax liability.
To help you finance the purchase of your options, Secfi also offers non-recourse financing. This allows you to exercise your options without paying out pocket, and could help you earn up to 26% more through tax savings in the event of an IPO.*
While making the most of your stock options can feel challenging, knowing the factors involved can demystify the process. With the right research and the right advice, you’ll be able to unlock the value of your equity and put it to work for you.
1This typically refers to Incentive Stock Options, also known as ISOs.
*Based on potential tax savings upon sale of the shares upon exit.