What to do with your stock options if your startup is going nowhere

By Angel Chavez , written on April 3, 2013

From The News Desk

Every year, starry-eyed young professionals from across the country flock to Silicon Valley hoping to land a job at the next tech giant. These young idealists sometimes get lucky. If their companies offer IPOs quickly, they could become multi-millionaires or billionaires. Others may not be so lucky. These unlucky ones may have to wait years to see their startups go public, or to see their stock options become valuable. While they wait, the employees of the slow-growing companies may feel like the only thing they can do is just sit on their stock options. But that’s not quite the case.

People can make money off of their stock options in a number of ways -- provided they meet certain criteria. Most startup employees’ stock options are not vested, in that they cannot be exercised until the employees meet certain corporate guidelines. Most of these guidelines are time-related. It is important for people who want to make money off of their options to make sure they’ve met all the criteria their companies have laid out for them to be able to do so.

For employees who meet all the criteria, there are a few ways they can make money off their options. However, these ways are not risk free, and if anxious startup employees wish to exercise them, they should consult a financial advisor to discuss the risks. Here are some options for stock option holders:

1. Sell the options

It’s hard to give up stock options, but there are ways for employees to give up a portion of their options, or all of their options, in exchange for money. There are financial groups that evaluate startups, put a price on the startups’ stock options, and then, if they feel the start-ups have potential, will look to monetize the stock options’ value from willing holders.

Of course, these types of financiers don’t want to lose money -- which is a risk, because the start-ups they evaluate could end up going nowhere. It is the standard practice of these financial groups to charge a fee or commission to the stock option holders they purchase stock from. They may take the commission out of the price of the stock options they purchase or directly from the holders’ wallets.

2. Use shares as collateral

In the same way that homeowners can put their houses up as collateral if they need to take out loans, start-up employees can also put up their stock options as collateral. But, like people who use their houses as collateral, people who use their stock options as collateral also risk never getting them back. There are also tax considerations when using stock options as collateral. People should consult their accounts before turning their stock options into collateral in order to make sure they’re making the smart move.

3. Just hold on

There are benefits for start-up employees who hold on and wait for their companies to go public. Their companies may actually become profitable and mega-successes. When companies go public, their employees will usually have the right to exercise stock options and buy stock at a lower price than the rest of the public. As such, when the employees purchase their stock, they are already profitable. If they were to sell their shares right away, they could make money immediately.

If people think their company will become a success, they should start to consider what they would do once they are allowed to exercise their stock options. They might consider 83 (b) elections.

The IRS, however, considers the expected earnings on stocks as taxable income. Therefore, some new stockholders may agree to do an 83 (b) election. By choosing an 83 (b) election, new stockholders will agree to have their expected profit, from the day they purchased their stock, be taxed at regular income rates within 30 days. The IRS will then agree to only tax the money the stockholders make afterwards from their stocks at capital gains rates – which are substantially lower than income-tax rates.

There is a significant risk to 83 (b) elections. Stock prices can tank. People who exercise 83 (b) elections may end up regretting that decision later if their stock’s value substantially drops by the next tax filing period. People who exercise 83 (b) elections may end up paying higher taxes by filing an election than those who wait to see their stocks’ price drop later in the year.

It’s not easy for many Silicon Valley professionals to sit, wait, and wish for their start-ups to go public and for their stock options to become valuable. These professionals can make money off of their stock options, but they have to evaluate all the risks and the tax ramifications involved with doing so to make the right decisions for them.