Vieje Piauwasdy
Director, Equity Advisory


When leaving a startup that awarded you ISOs, it used to be that you were pretty much screwed.

Your ISOs would expire within three months (due to their so-called 90-day post-termination exercise window), so you had to either buy the shares before the exercise deadline – often triggering a hefty tax bill – or let go of your hard-earned employee equity.

Luckily, more and more startups are now willing to extend exercise deadlines by 5 or more years. Examples:

  • Mixpanel: 5 years
  • Coinbase: 7 years
  • Quora: 10 years

There's one caveat. If you take the extension, your ISOs convert to NSOs.

So – should you do it?

TL;DR

If you're optimistic about the company, it's probably better to exercise your ISOs now rather than converting to NSOs.

The reason? If there's a successful IPO (and you meet certain requirements – see below), you save on taxes, so you'll take home more.

Of course exercising isn't free, so this only works if the costs aren't too high – or if you are eligible for exercise financing at good enough rates (so you're still at a net benefit with the tax savings, despite the financing fees). Otherwise, take the NSO conversion.

The long answer:

If you don't want to lose your equity, you have 3 options

Each with their pros and cons.

A. Exercise your ISOs, pay for it with your own money

👍 Reduced IPO tax (you'll earn more in a successful IPO)

🚫 You pay exercise costs, including taxes

🚫 You risk losing money (if no/mediocre IPO)

B. Exercise your ISOs, pay for it with exercise financing

👍 Doesn't cost you anything

👍 No risk of losing money (if unsuccessful IPO)

👍 Reduced IPO tax (you'll earn more in a succfessful IPO)

🚫 However, (a part of) your tax savings goes to financing fees

C. Convert to NSOs, don't exercise

👍 Doesn't cost you anything

👍 No risk of losing money (if unsuccessful IPO)

🚫 High IPO tax, so you'll earn less in the IPO

Note that with a "successful IPO" I mean one where the exit value of your company is high enough, so you can sell your shares at a profit.

Which of these three options is the best?

You can make the highest amount of money with Option A

...if you can afford it.

By exercising your ISOs, the profit you make in the IPO can get taxed as long-term capital gains. That's a substantially lower tax rate. The difference can be lucrative – see this Snowflake case study (tax savings: $135,000) or these Pinterest examples (tax savings: $106,370).

You'll get long-term capital gains if you check two boxes:

  1. You sell your shares at least 12 months after exercising your ISOs
  2. You sell your shares at least 24 months after the ISOs were granted to you

More about long-term capital gains in this blog post.

Of course Option A is only an option if you can afford the costs to exercise, including the tax bill you'd trigger. (You can use this online calculator to see what your costs would be.)

Also, going this route means putting your money at risk. If your company doesn't manage to have a successful exit, it's gone.

Otherwise, whether Option B is best for you depends on 2 things

Optimistic about an IPO, but option A not possible? 

Then Option B is best for you if:

  1. Exercise financing is available to you
  2. You can get it at good enough rates

Both depend on the company you work(ed) for.

If your company isn't eligible for exercise financing, Option B is also not an option and you should go with Option C: convert to NSOs.

But if you can get exercise financing at good enough rates, you're better off with Option B in case of a successful enough exit. Even though you'll owe fees, you'll be at a net benefit versus Option C due to the reduced IPO tax.

So, in summary. Assuming good financing rates and assuming a successful exit, your best option is A, then B, then C. For Option A you'll have to come out of pocket, while B and C won't cost you anything.

Example

We recently helped an employee at high-growth fintech startup.

This was her situation:

  • ISOs: 25,000 at a $3.30 strike price
  • Exercise costs: $212,500. That's a $82,500 strike price + $130k in taxes

With the financing rates we were able offer her, here's how her three options compared, depending on the exit value of the company:

If her company would IPO at a value anywhere north of $4 billion, she'd make the highest amount of money going with Option A, then B, then C. Her company was last valued at $8 billion by investors.

She felt confident about a future IPO. But the exercise costs of $213k were too high for her to cover herself, so she went with Option B and used Secfi to fund the exercise costs.

How to decide? Use this flowchart

Step by step:

  1. Use this online calculator to check what your exercise costs would be (including taxes)
  2. Exercising affordable? Confident the company will go on to have a successful exit? OK with the risk that you might lose your money? Go with Option A: exercise your ISOs, paying for it yourself
  3. Exercising too expensive? Check if exercise financing is available to you, and at what rates.
  4. Exercise financing available at good rates? Expect to check the boxes for long-term capital gains? Go with Option B: exercise your ISOs using exercise financing
  5. No exercise financing available? Go with Option C: take the deadline extension and convert your ISOs to NSOs

If you need a sparring partner, happy to help out. Just hit me up for a quick chat ↘️

How to quickly check the rates at which you can get exercise financing

If you're considering Option B:

  1. Create a Secfi account and enter your equity details (takes 3 minutes)
  2. Once logged in, request a financing proposal (takes 1 minute)
  3. If eligible, we'll send you a detailed proposal catered to your situation

You'll basically get the above chart, but personalized. It models out your specific scenario and shows your benefits under options A, B and C.

We'll also invite you for a quick "we answer all your questions" call, where we can discuss anything. Feel free to ask about rates, stock options, taxes, ISOs vs NSOs, how IPOs work...

For a lot of companies (e.g. Coinbase, Procore, Gitlab, Segment) we already have rates because we've worked with employees before. If you're at one of those, the process is fast-tracked and you'll have the proposal in just a few days.

On the fence between Option A and Option B? 

Just do a mix of both.

If you want exercise your ISOs but are not totally comfortable covering the costs with your own savings, it's perfectly possible to exercise up to a certain amount at your own cost, then use exercise financing for the remainder only. That way the fees will be a bit lower, and you'll have best of both worlds.

You can decide up to what amount you're comfortable putting in. Just let us know, and we'll include that scenario in the financing proposal.

Converting to NSOs? Two additional things to consider

1. If you take NSOs and don't exercise right now, but later decide you still want to exercise after all, it's probably more expensive

The tax bill from exercising will be higher for two reasons:

  1. NSOs have a less favourable tax treatment than ISOs
  2. If the company continues to grow, its 409A valuation will continue to rise

If you want to see the impact of ISOs vs NSOs as well as higher 409A valuations, use our free Exercise Tax Calculator. If you add your stock options twice – once as NSOs, once as ISOs – you can toggle both and see the difference.

2. An extended deadline is great, but still no guarantee your company will in fact exit within that deadline

If it doesn't, you'll still lose your equity when the deadline expires. That's not a risk if you exercise your stock options instead. Good to consider especially in case of a 5 year extension.

In 2013, Palantir's co-founder guessed the company would IPO in 2015 or 2016. It went public in 2020.
Vieje Piauwasdy
Director, Equity Advisory

Vieje is an equity compensation and taxation expert for Secfi. He guides startup employees through the complexities of private company equity to ensure that no money is left on the table. He is a proud San Francisco native and University of Washington alum. After years of experience at PwC, he decided to make the jump to tech after being promised he would never have to wear a suit again (picture is outdated).


Hope that was helpful
Ready for personalized equity insights?
Create your free account.
Enjoying
this guide?

Enter your email and we’ll let you know when we add the next Equity Academy guide.