Do we buy and risk it?

[LivingAlmostLarge]

So we're in an interesting conundrum. You guys know our backstory and the startup is going well. Well enough and tired enough after 3 years that our stocks are vesting and final next February. So DH instead got options instead of shares like he did when he helped start the company. Anyway with options there are a couple of things.

1. We need to decide we can decide to early exercise our stock which means buy them all now.
2. We can buy them as they vest.
3. We can wait to buy them until an event happens like a buy out or merger or ipo and then never see the cash but do a "cashless"exercise and the proceeds cover the sale.

But each decision has a different tax consequence. It also has a different cost.

So what do we do? We are leaning to buying all. If we do we don't have to pay taxes on the spread. If we don't we have to pay taxes on the spread when the Fair market Value changes. Right now we are pretty sure the FMV will change. The 409A which sets the valuation is a bit older. So it's not a terrible risk. Of course it could always go to zero like my negative DH says.

But the issue sort of is coming up with the cash. I either have to cash in some stocks to do it, or I have to cash in our ibonds which was our EF, or I have to figure out away to pay for it. If it had been a month or two ago I had the cash but I invested it in our portfolio.

Thoughts? Ugh>

[disneysteve]

I know nothing about stock options. Is it an all or nothing decision? If you chose #1, do you have to exercise all of the options at once. Or can you exercise some now and the rest as they vest?

As for raising cash, if you just bought stock a month or two ago, even with the recent run up, your gains probably are fairly minimal so there'd be some tax impact but hopefully not that much.

[QuarterMillionMan]

I can explain options in simple terms. It is the same as buying and holding or short selling but with time limits such as 60 days or 90 days expiration. The time limits makes options extremely risky. I lost a lot of money trading options and no longer trade options.

[LivingAlmostLarge]

These options don't expire quite like that but definitely what qmm said is true. More like it's an option to buy in a company.

We do not have to buy all we can buy some or none. The options are in the startup she is doing. So it's risky but if we didn't believe it then he wouldn't be working there.

That being said it's beneficial to buy it all now. There are tax repercussions to waiting.

so if we buy now we pay the $10 a share for the options and they are ours and not options to buy. They become stocks and the long term capital gains clock starts ticking.

Now if we waited then when we do decide to purchase them if the fair market value is $20 but we can buy it for $10 we have to pay $10 and we have to pay the taxes on the $10 spread to hold onto them until we sell. Then when we sell determines if it's short or long term capital gains and how it's all treated.

However most people don't buy options in their startups. Most people only buy when forced meaning the option to buy the stock is about to expire. Or if there is a buyout, merger or IPO event. Then people never foot the cash to buy they just sell the option and at that moment they purchase it with the cash they are earning from the immediate sale.

Iit's called incentive stock options and it's how small companies tempt people to work for them. The share they get offered are a dollar then suddenly the share at 10x and worth $10 then $20 then $30 then $40.

I recently saw clients who cashed out their options for more money than they dreamed of. A bunch has options from $1-32 and the buyout was $44. They did well but not retirement well.

Another one I saw was $7 option that they sold for $300 a share and even now selling more like $150-180. Millions cashed in.

So I don't know how to measure risk and i was about to sell bonds to get into the $1.3 fixed rate. Debating now do I just cash in to fund this?

[kork13]

Caveat: I'm not super familiar with options beyond the basics ... so I could be missing/not considering a potentially important issue.

How much $$ are we talking about here? Sounds like you don't readily have the cash available to execute all of the options right now ... if that's the case, and you were to execute what you do have the cash for right now ... when would you have the money to finish them out?

I'd look at it primarily from a tax standpoint. If executing them all now/ASAP will minimize the long-term tax impact, I'd likely do that. That said, I'm not sure I'm following the tax downside of holding the options long-term. If you continue to hold the non-expiring options, wouldn't you only pay taxes on them upon execution & sale of the resulting stocks (with the basis still being the same $10/sh)? I may be misunderstanding though....
***ETA: Actually, I do see how executing & selling the shares all at once would make the sale STCG vs. LTCG, which would change taxation alot ... So wanting to start the LTCG clock makes sense at least. But I still don't see the harm of executing the options more slowly (ex: as they vest).

Clarification question ... if you execute them now & take possession of the shares, does that negatively impact your upside in the event of a future buyout/IPO? Logically, it seems like the date you execute the options shouldn't matter value-wise, because you're getting them at $10/sh regardless, and if you hold them as of tomorrow or as of the IPO day, your shares would still be worth the same amount.

[LivingAlmostLarge]

It's a bit of money. So I just checked treasure bonds and I have $120k there right now I can cash out and put towards it and be a little short. I was going to roll it and build the ibond ladder with a better fixed rate component but I'm thinking of cashing out everything for the past 6 years and then starting over again. I'll have $20k ibonds from this year and the $20k gift for next year as well. This was our massive EF in case of emergency raiding fund.

I don't think this counts as an emergency.

[jenn_jenn]

I personally wouldn’t be comfortable pulling from an EF for this. You mentioned that you’d have the cash on hand a few months ago but then invested in your portfolio. Can you sell from your portfolio to pay for the options?

Based on the limited info from this and your post history, I’d also be inclined to exercise early and buy all, or as many as possible, but I’d rather sell existing investments (assuming non-retirement and no detrimental tax implications) than use our EF.

[LivingAlmostLarge]

I hate pulling money from our brokerage accounts and while the bonds will generate taxes I was in the process of selling them to reinvest in the new fixed rate of 1.3% anyway.

I hate selling stock. It's probably stupid but I feel like I'm failing like kork said if I pull money out from somewhere that normally doesn't come out only go in.

[LivingAlmostLarge]

I should add it's not our ef it's just our next level ef. We have an ef in cash sitting in our capital one and I'm getting up the courage to move it to vanguard like everyone else. But hi have all our sinking funds there now