Buying stock options in private company

Question

I have been working at a start-up company for the past 4.5 years in the US. The company is still private. It is not going to go public. The owners are looking to sell once they get a good offer. I don't think they are going to sell in the next few months, but maybe in a year or two.

I was offered stock options for 20,000 shares at strike price of $0.11 when I joined (vested for 4 years). These are fully vested now. I got 5000 more shares a year later at a strike price of $0.25, again vested for 4 years. I haven't exercised any of my options yet. I heard unofficially that at the last funding round (about a year back) the investors purchased shares at a price of $1.75 per share.

My question is this: if I buy all the shares that have vested, then I will be paying the company around $3100 (20000*0.11 + 3750*0.25). I have the money to buy. Assuming the company is not sold within a year, I believe I need to only pay the long-term capital gains tax when the company sells, right? But if I do not purchase the stocks now and the company sells later (assuming I still work for the company), then I believe they will just deduct the strike price and give me the profits, but this will be taxed as ordinary income? (I am at 33% tax bracket; married filing jointly).

I believe in the people running the company i.e. that they will make sure their own money and efforts do not go waste, so is it a wise bet to buy the shares now to save on taxes later?

What advice would you give in case I am leaving the job in the next few days? Believe I have maximum 90 days after I quit to buy the shares.

Answer 1

It is a very complex question to answer and it really depends. However, here are some points to consider and verify with your accountant or tax expert. First, if you exercise now, the downside is that you may be subject to Alternative Minimum Tax (AMT) based on the theoretical gain on the stock (current price minus your strike price) when you file your tax return. The other obvious downside is that if the company goes nowhere, you are stuck with the stock and potentially lose money. The benefit is that the clock starts ticking for long-term capital gains so if you sell after 1 year from the exercise date (or your company gets sold) then the gain would be taxed as long-term capital gain which is taxed at a lower rate.

If your company were to get sold, the gains are not necessarily taxed as ordinary income. If it is a cash transaction then most likely (unless you have exercised and held the stock for over a year). However, if it is a stock sale, then you may end up getting stock of the company that acquires your company. In that situation, the tax event would be when you sell the new shares vs. the time of company sale.

Finally, whether to exercise or not also depends on how you feel about the prospects of the company. If you think they will be sold or of more value down the road then exercising makes sense. If you are not sure then you could hedge your bets by only exercising a portion of it.

You should definitely consult with a financial advisor or a tax consultant regarding these matters.