March 10, 2021
Should you wait until your company IPOs to exercise your options, or should you exercise beforehand to increase your after-tax profit?
The tax savings could be huge.
Use our calculator to see the difference given your personal equity and tax situation:
Here's what the calculator looks like:
When you exercise options, you buy company shares. If you hold them for a year before selling them, the money you make is taxed at the long-term capital gains rates. Otherwise it's taxed at ordinary income rates, which is a higher tax rate.
That means that if you exercise early enough, you'll get a tax discount, and maximize your net profit in case a successful IPO or acquisition happens.
The difference between these two tax rates adds up quickly. The gain can be as high as 30%.
Consider for example Freya, a Pinterest tech lead:
We’ve written a bunch articles about the potential benefits of exercising prior to an IPO, with plenty of real world examples of employees of Pinterest, Snowflake and DoorDash paying far more in taxes than they could have.
But the exact gain you'll get depends on your specific equity and tax situation, as well as how successful of an exit your company will have.
That's why we built the Pre-Exit Exercise calculator, which takes these things into account and lets you model out various scenarios.
As explained, exercising pre-exit may reduce the total taxes you would need to pay. We built the Pre-Exit Calculator to help you calculate how much of a difference it makes, and how high the upfront cost of exercising is. If the difference is small, exercising might not be worth the risk.
You’ll need to enter the future exit value of your company – which, as we know, is uncertain. So it's good to consider multiple scenarios. Here’s what to do:
Especially if you’re an early employee, the exercise tax bill can be hefty.
If this puts exercising out of your financial reach, there are two things you can do:
Another solution is to do a mix of the two: exercise as many stock options as your personal budget allows, then have Secfi fund the remainder.
Great question! First we calculate what it would cost you if you were to hold on to your options until the IPO, and sell all your options straight away at an exit price of your choosing, the proceeds of which would be taxed at ordinary income rates.
Then we calculate what it would cost you if you were to exercise today, and sum this with our calculation of your long term capital gains taxes if you sell the shares a year later. Subtracting the exercise scenario from the wait till IPO scenario then gives you the potential savings if you were to exercise today.
Early exercising is when you exercise your stock options before they vest.
This may increase your profit by minimizing your overall taxes, as well as decrease the upfront costs when you exercise.
Early exercising is something not normally possible: companies have to specifically allow it. Ask your employer or check your option grant if you’re not sure whether this is the case for you.
Learn more about early exercising here.
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