Exercising pre-exit can increase your profit because of tax savings. Normally, your payout (minus the strike price) is taxed as ordinary income. If you exercise pre-exit, a part of it may be taxed as capital gains instead. That's a lower tax rate.
The key question is: how much of a difference does it make – and how high of an upfront cost does it take? If the difference is small, it might not be worth the risk.
The answer highly depends on your tax situation, income, and type of stock options. How they impact tax savings is complex, but Secfi offers Pre-Exit Exercise, a free tool that helps you crunch the numbers. Based on your details, it forecasts the difference in profit between exercising now vs. waiting for the exit.
There’s one caveat: Pre-Exit Exercise requires you to input the future exit value of your company – which, as we know, is uncertain. So that’s where your exit value forecasts come in. Here’s what you do:
- Create a Secfi account and enter your equity details.
- Navigate to the Exercise Tax Calculator to learn about your upfront costs.
- Next, navigate to Pre-Exit Exercise.
- Enter as exit value your base scenario forecast. See how exercising pre-exit affects your profit in this scenario.
- Now enter your dream scenario forecast. Consider the difference again.
How did that make you feel?
If the differences in profit are small, but the upfront costs are high, it’s probably not worth it. Conversely, if the upfront costs are affordable, consider exercising all your options pre-exit.
It gets tricky when the differences in profit are substantial, but the upfront costs are too. You’ll then want to find a middle ground: decide on a budget to exercise some of your options now, leaving the remainder unexercised.
Deciding on that budget is difficult since it’s somewhat of a gamble. Say you budget $5000. Now if your company ends up having a very successful exit, you’ll wish you’d spent more than that, since you could have maximized your profit even more. If on the other hand your company fails, you lost $5000 and wish you’d spent nothing at all.
What’s the amount of money you can forgive yourself losing in a bad scenario? The choice is a personal one. But at least you now know what the potential benefits are.