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I asked my employer (a Series A startup) if I could early exercise my stock options for the tax benefits described here. They replied that that would not be possible because the company did not issue RSUs (which, they say, startups rarely do) and because issuing them now would add regulatory burden.

Is that a reasonable rationale for not offering early exercise? Would it actually be that difficult or costly to a startup that already offers equity compensation through stock options to offer early exercise of those options?

  • Regulatory burden increases when there are 500 investors, 2000 accredited investors, or $10M in assets. Not knowing how many past and future employees and investors they expect to have before they go public (or hit $10M in asset value), I can't opine if this is a reasonable rationale. sec.gov/info/smallbus/secg/… – user662852 Jan 7 at 17:19
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    Who cares about our opinion? For them it is a reasonable rationale. – Pete B. Jan 7 at 20:03
  • If it's unreasonable, that informs my decision about whether to push more, as well as how I handle my relationship with the company moving forward. – 0000001 Jan 8 at 15:54
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Are you sure you would even want to exercise your options yet?

There is no guarantee for a market to sell your equity once you have it; there rarely is an opportunity to sell an interest in a private company until it goes public.

Exercising your options early would mean that you need to pay now, to get... possibly some money in the future. For many startups, that value never materializes, which is why options are often offered on top of meager compensation, so that key employees take on a shared risk of business success, and work harder as a result to capitalize.

To put a final cherry on this point, remember the adage that you shouldn't spend money to save 30% on taxes. Your financial decisions should come first, and not be driven by a smaller component of tax.

In answer to your question, the response seems reasonable, and even if it weren't... that is just the 1st roadblock you will face in attempting to actually get cash value from options in a private startup company.

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  • My company has nearly doubled its valuation (now around $40M) in the last few years. The risk of equity being worthless is still there but seems low relative to a company with less momentum. If I'm confident that the options will provide a good return, locking in a low tax on their exercise seems like it could be a good financial move, even if it locks up some of my dollars. The biggest risk to me is me leaving the company and not getting the unvested stock I've paid tax on during the exercise. – 0000001 Jan 8 at 16:26
  • @0000001 Valuation according to whom? Even if the valuation is correct, without going public it can be very difficult to sell shares in a private company. There may even be rules restricting how and when shares can currently be sold - you may need to wait 5+ years for the opportunity. Are you willing to pay the exercise costs now to save taxes 5 years from now? – Grade 'Eh' Bacon Jan 8 at 16:29
  • Fair point. Valuation according to the most recent investors. Unfortunately I didn't learn about early exercise until a new 409A valuation was done following my options grant, so I wouldn't be able to lock in zero tax now. If it's still a small amount, though, yes, potentially I would consider the expected value of the decision to be positive. – 0000001 Jan 8 at 16:45
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I don't think their reply quite makes sense, because early-exercised stock options are not RSUs (when you early-exercise a stock option, I believe you get (restricted) shares of stock, not stock units). Early exercise of stock options is mostly only found in early stage startups (because at that point the price is very low, so there is little risk; and 83(b) election allows it to be taxed at exercise, which results in no tax if exercised at option grant since there is no spread between exercise price and market value), so if they are saying that it is something startups rarely do, then that clearly indicates that they are thinking of something else (RSUs not early-exercised stock options).

However, whether to allow early exercise (exercise before vesting) is their choice, and if they don't want to offer it, there is not much you can do.

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