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Let's say I'm an employee at a startup where I own fully vested stock options.

Scenario 1
I have not exercised my stock options and my startup was bought.
Do I still get to exercise my options? The income tax I have to pay for them will be based on the value the company was bought at?

Scenario 2
I have exercised my stock options and my startup was bought.
When I exercise my options, what will my income tax be based on? I assume it's the current value of the company as determined by the IRS. When is that value calculated? I don't think they come up with the new valuation each time someone decides to exercise.
After the company is bought, do I have to pay more taxes on the plus-value between the estimated startup value at the time I exercised vs the price at which it was bought?

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Scenario 1

Only your company can tell you if you can still exercise the options, and under what terms. Part of the agreement to sell a company includes dealing with the employee's benefits and options. Since the company that gave you the options no longer exists - there's no default answer, you should check your specific situation. In many cases, in this scenario, options are replaced by the options to the new company, with a new vesting schedule.

Scenario 2

In this scenario, you exercised the options before the startup was bought, which effectively made you one of the shareholders selling.

Your income will be based on the valuation of the company, and if it is not a publicly traded company - its a fairly complicated matter. You should get a professional (EA/CPA licensed in your state) to work on this with your company.

When you sell your shares in the buyout by the new owner, you will realize gain which is of course taxed. That would be taxed as capital gain, based on the difference between the valuation you've been taxed upon, and the sales price.

A thing to remember: if you're exercising the options and keeping the stocks - you may get hit by the AMT. I suggest talking to a professional adviser (EA/CPA licensed in your state) to plan accordingly.

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  • In the second scenario could the acquirer issue options to the stockholders that only vest after a certain amount of time spent working at the new company? I often see founders stuck at the new company when they're acqui-hired. What happens in that case to stockholders that do not work for the company anymore and those that work for it and leave right after the acquisition?
    – Youcha
    Commented Mar 2, 2014 at 1:11
  • @Youcha yes, it is a possible scenario, and in fact that is what happens many times. Stocks in the old company are sold, per the purchase agreement, but options are not and are frequently replaced with conditioned options with a new vesting schedule.
    – littleadv
    Commented Mar 2, 2014 at 1:26

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