Meet your cash curve

When your company exits, your cash curve determines how much you’ll make

The purpose of your ISOs and NSOs is to one day make you money. That one day is called the exit. It's when your company either goes public through an IPO, or gets bought by another company. ✱

If this is new to you, read about the Option Lifecycle in the Stock Option Starter Guide.

If and when the exit happens, the amount of cash coming your way depends on how successful your company has become. That level of success is your company's exit value

Unfortunately, the exit value is unpredictable. So you'll never know for sure how much you'll make. The only thing that's certain: as the exit value increases, you make more.

But how much more? That’s what your cash curve tells you. Everyone’s curve is different, but yours may look like this:

At Secfi, we’re working on a tool that computes your personal cash curve. We’ll be launching it soon and for free. In the meantime, ask your CPA to determine it for you.

Your cash curve is the relationship between the future of the company and your future wealth. You read it like this:

Happy with this cash curve? A thought experiment

Of course, life is not about cash. Life is about happiness. 

So – how happy are you with your cash curve? That can be difficult to say just by looking at the graphic.

Here’s a mental exercise to add some color.

Imagine that in a couple of years – years of hard work – your company IPOs. As a result, you receive $1,000,000. Would you consider that life-changing wealth? Or rather ‘just’ an awesome bonus? 

Now imagine it was $150,000. Would that be a nice bonus to you? Or would you be disappointed?

1. Consider your money feelings

What about other outcomes? Take a moment to reflect and determine the amounts that would leave you feeling each of these five ways:

Call these your money feelings. They're how you would experience possible financial outcomes – how wealth translates to happiness for you.

The thresholds of money feelings are a personal matter, so they’re different for everybody. Perhaps yours look like this:

2. Consider your exit expectations

Another personal matter is your confidence in the company.

You probably have some intuitive idea of how successful you'd expect your startup to become. Most likely, it's a rather vague idea. That’s totally fine. Startup exit values are inherently uncertain numbers, so vague is the best you can do.

In broad strokes, what exit values would you see your company achieve in the future? ✱ Which are probable? Which are possible? And which ones are – in your humble opinion – never gonna happen? 

If this is difficult for you to answer intuitively, read about gaining exit intuition in the Stock Option Starter Guide.

Call these your exit expectations. They might look something like this:

3. Combine and judge the full picture

As the final step in this thought experiment, let your money zones and your exit expectations give context to your cash curve.

Against this backdrop, consider the curve again. Have a good hard look. 

What do you think? Does it make you excited about the future? Would you consider it a fitting reward for your contributions to the company?

Under this curve, does this startup adventure feel worth your time?

Exercising: why, how much, and when

Exercising options = buying a better cash curve

If you’re not content with your current cash curve, you may be able to improve the situation by exercising your stock options.

But exercising is not free. So the question is: is it worth the price?

When exercising options, you pay money to crank up your cash curve. The more options you exercise, the more it costs – but the better the curve gets.

The specific numbers depend on your situation, but illustratively the idea is this:

By paying today, you buy yourself a chance of additional profit years from now. But if your company fails, you’ve lost that money.

It's like being a confident football player and then betting that your team will win. You’ll motivate yourself even more to make this a reality, and it's extra awesome when you succeed. (Extra painful otherwise.)

There's a whole catalogue of cash curves

Depending on your type and number of stock options, your tax situation, and a whole bunch of other things, you have access to various cash curves. All with their own price tag. 

Let’s call that your curve catalogue.

At Secfi, we're currently building a tool that takes your details and computes your specific curve catalogue. Until it launches, work with your CPA to discover what’s available to you. 

Knowing your curve catalogue is one thing, but how do you pick the right one?

In other words: how do you decide on the right amount of money to spend on your stock option exercise? Here’s a way to do it. 

Pick the curve that makes the future feel good, discounted by the painfulness of paying for it today

Browse through your catalogue. Arbitrarily take a couple of the available curves. Then go through that thought experiment again:

  1. Imagine your money feelings alongside the vertical axis
  2. Imagine your exit expectations alongside the horizontal axis
  3. Judge how each different cash curve makes you feel about contributing to the future of your startup 

But this time:

  1. Also take their price tags into account 

Example: say there’s one cash curve that gets you excited, but it costs $70,000. Is that worth it?

Well, what is the opportunity cost of that $70,000?

How painful would it be for you to pay that amount today? Would you need to plunder your savings? Tone down your travel plans? Eat out less? Stop investing in public stocks? Sell your car? Borrow from friends and family?

It’s a trade-off. A steeper cash curve increases your future happiness – but by paying for it, there’s present happiness you miss out on today.

If – all things considered – that cash curve still feels right, it might be worth it. That’s how to decide on your options exercise.

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The best time to exercise is probably today, and the clock is ticking

What we haven’t covered yet is when to exercise. 

Barring a few exceptions: if you are optimistic about your company, the best time to exercise is now. ✱ (If you’re not optimistic, you shouldn’t be exercising.)

The reasoning is as follows. If you are considering exercising, it means you are optimistic about the growth of your company. If you are right about that, then unless you have a specific reason to assume the 409A valuation will go down (while holding this optimistic view about your company!), you should be expecting it to go up. And as soon as it goes up, costs of exercising increase. 

You could argue that this buys you extra time to watch the future of your company unfold. But are those extra months worth the potentially doubling costs? Unless you foresee a critical ‘do or die’ moment for the company in the near future that you’d like to await before making the decision, we’d argue no: there will alway remain uncertainty in a startup.

If you agree with that logic, it means the theoretical optimal moment for you to exercise is right before the 409A valuation updates: you’ll then know more about the fate of the company while still exercising for the same cost. But unless you’re in the position to anticipate that moment with confidence, it’s a tricky optimization.

There’s one exception, which is when you’re reading this in November or December. That late in the calendar year, while you may not be able to anticipate the precise date the 409A valuation will be updated, you may be able to determine whether that’ll still be before January 1st. If you’re pretty sure that it won’t, you could exercise stock options in two batches: one batch this calendar year, and the other in the next, so as to avoid entering a higher tax bracket.

And the clock is ticking. While today versus tomorrow won't make a difference, ✱ your curve catalogue doesn't stay the same indefinitely. Over time, it changes for the worse: assuming your company keeps on growing steadily, each cash curve gets increasingly more expensive. 

Unless you're very unlucky and your company announces a new 409A valuation tomorrow. (Read on to learn what a 409A valuation is.)

In other words, spending the same amount of money on your option exercise will get you a worse cash curve in the future than it would today.

So how much time do you still have to make your decision? When does that catalogue change happen? 

This gets a bit technical, but it's when the 409A valuation updates.

Like all startups, your company is required to have a third party make a valuation of its shares for tax purposes. This so-called 409a valuation directly impacts your exercise costs: if it goes up, exercising becomes more expensive

The 409A valuation goes up if the independent valuator believes the company is in a better shape than it was last time.

Re-valuations happen at least every year, but also whenever something big happens to the company. The typical example of ‘something big’ is raising a new investment round, but it could also be winning a substantial sales deal or entering a key partnership.

Note that the moment something big happens, your company is required to freeze option exercises and order a tax valuation update. You won’t be warned (your company is not supposed to, at least) – that’s the point.

If you want to anticipate this, discuss with your leadership when they expect the next re-valuation to happen. They won’t be able to say for sure however, because those ‘big events’ aren’t always planned. It's a good idea to be on the safe side and make up your mind well in advance. 

Two major caveats

While that's the core idea of exercising stock options, there's actually a little more to it than the above story. There are two complications we can’t ignore.

1. Your catalogue changes if you leave the company before the exit

At most startups, you will lose your unexercised options if you leave before the exit, ✱ whether that's voluntarily or involuntarily. This severely impacts your cash curve, changing the entire decision.

Well, you won’t lose them directly – you’ll have them for another 90 days.

In practice that means you will have lost the options by the time the company exits, unless the exit so happens to take place within this 90-day window after your leave.

Of course, when you indeed leave, you can still choose to exercise and secure your equity within those 90 days. But if you already know you would be willing to do that, then why not spend that money today instead?

Assuming your company keeps on growing steadily, the 409A valuation will have gone up by that time, so you’d get less bang for your buck.

Here’s what it might look like if you exercise, say, half of your options – letting go of the other 50% if you leave:

For your decision-making, this means that if you already know there’s a fair chance you won’t be around for the exit, you should be looking at a different catalogue than if you think you’ll stay:

Will you stay until the exit?

In case you’re not yet sure what your future holds, then it’s well worth planning for all eventualities. Our upcoming curve catalogue tool will allow you to toggle ‘stay’ and ‘leave before exit’, so you'll be able to consider your curve catalogue under both scenarios. Work with your CPA until it launches.

2. Future investment rounds will hurt your cash curve

Even if you do stay with the company until its exit, your cash curve today still won’t accurately describe the amounts of cash you’ll ultimately walk away with.

That’s because every time your company raises capital, a larger part of the eventual exit value will go to investors, and a smaller part to you.

This is called dilution. The more you dilute, the worse your cash curve gets. That could look something like this:

How much dilution is still ahead of you? That’s uncertain. It is correlated with the amount of capital your company will raise until the exit, but how much it’ll be exactly is anyone’s guess. 

So when you exercise your stock options, keep in mind you’re buying a cash curve that's still to get worse. It’s just not clear how much worse.

If – while making your exercise decision – you want to anticipate future dilution, your best bet is to ask the leadership of your company. While they won't be able to tell for sure, they should be able to provide you with a rough idea of expected dilution based on their fundraising plans. 

Your CPA can then draw out the resulting cash curves. Up to you to decide whether they’re still worth their price.

Appendix: The full deep dive

We discussed everything you need to know to make your exercise decision. But perhaps this guide left you wondering things such as:

  • Practically speaking, after I’ve made my decision, how do I actually exercise?
  • What factors determine my cash curve?
  • Why is it that exercising options influences cash curves?
  • What about early exercising?
  • What if I have multiple option grants with different strike prices?
  • How does an increased 409A valuation make cash curves more expensive?

We’re extending this guide soon with an appendix that covers these questions in full detail.

Hope that was helpful
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