Welcome to the 13th edition of the Tech Financial Planning (TFP) Newsletter.
If you joined Procore in ~2016, received 100k stock options, and exercised them all, you would take home $3.77M after taxes if you sold everything today.
But if you waited until Procore was public to exercise and sell (for argument’s sake, let's also say today) you’d take home $2.87M – a difference of $896,680.
Let’s break it down.
In this newsletter we will break down why you might consider exercising your options before an exit, the potential tax savings, and the risks
TL;DR
Exercising early can save you a ton of money in taxes
It can be risky because you a putting up cash in a company that is still private
Waiting has consequences, namely, higher taxes
The Early Exerciser
Let’s say you joined Procore in 2016
Depending on your position, you might have been offered 100k incentive stock options (ISOs) vesting over 4 years with a 1-year cliff
In this case, we will assume that Procore lets employees early exercise
This is when you actually exercise your options before they vest.
The advantage here is that you can exercise when the 409A valuation is likely lower, which means lower taxes.
Candidly, most startups don’t offer an early exercise, but to make it simple, we’ll pretend that it’s available in our situation.
Back in 2016, these options probably had a strike price of around $2.00
Which means if you wanted to exercise all 100,000 of your options, you would have to spend $200,000 (100,000 options x $2 strike price).
Certainly a pretty decent chunk of money.
But if you had several years of experience and were a diligent saver, something you could consider.
Note: the strike price (or exercise price) is the price you pay to buy one of your options at and the 409A is the most recent valuation price.
When you exercise your options, you are taxed on the difference between these two prices: immediately for NSOs, and deferred for ISOs until you sell your shares, (unless you trigger AMT, which for the sake of simplicity, we will ignore here)
Fast forward to today and that stake is now worth ~$5.47m (100k shares * $54.47 price per share at market close as of 10/29/2022)
If you were to sell them all, if you live in California, you’ll pay a 37.1% tax rate (23.8% federal capital gains + 13.3% CA tax).
So you will pay 37.1% on your $5.27M gain ($5.47m value - $200k cost to exercise).
Please note, the 37.1% is the marginal tax rate, not the effective tax rate.
This means you will pay $1.68M in total taxes
Leaving you with $3,768,475 after taxes.
Playing It Safe
On the flip side, you may have waited until Procore went public to start exercising your options.
In this case, you didn’t want to exercise any of your options while Procore was private and now are ready to exercise and sell all at once.
While your Procore shares will still be worth $5.47m, you’ll take home $2.87m in cash (vs the $3.77m in cash if you had exercised earlier)
In this scenario, the sale would be treated as ordinary income and be taxed at 37.0% federal + 13.3% state (CA).
Which means you will pay a whopping 50.3% tax rate on your $5.27M gain.
Again, the 50.3% is the marginal tax rate, not the effective tax rate.
You would pay $2,575,204 in total taxes.
Some Notes
Of course, this newsletter:
is merely an example to illustrate two possibilities
isn’t financial advice
requires personal financial info to provide a recommendation
pits two extremes against each other
is focused on one of the (very) few startups to have a successful liquidity event.
I can’t hit this last point enough.
It’s easy to look at a successful startup that made it and say wow, what a great decision to exercise early.
But if Procore didn’t have a successful exit, our first employee would be out $200,000.
That can be a big risk to take.
Putting It All Together
So what can you do?
If you’re a Procore employee, take stock of your situation. Figure out:
How many options you own, if any
Your tax burden
A strategy for your equity
If you’re working at a different tech company, this should be used as a reminder to figure out your own equity situation
Spend the time creating a strategy and making some choices.
Even if you don’t exercise now, understanding the implications could be worth hundreds of thousands of dollars in an exit.
At the very least, there will be less surprises.
In either situation, a financial and/or tax advisor can help you through the many questions you probably have as you navigate your equity.
Here at Coastal Capital Advisors we specialize in helping tech employees with these exact problems.
Equity, taxes and all the complexity that come with it aren’t easy to understand (and your company won’t can’t and won’t give you much guidance).
But taking the time now could pay big dividends in the future.
WHENEVER YOU'RE READY, THERE ARE 3 WAYS I CAN HELP YOU:
1. Want one on one help? Schedule a 25 minute “Are We A Fit?” meeting
2. Subscribe to the “Tech Financial Planning” newsletter to get equity comp and financial planning strategies in your inbox every Saturday. It’s free: TFP Newsletter
3. Connect with me on LinkedIn, where I post every weekday (unless I’m on vacation). https://www.linkedin.com/in/marshalljoe/