Employee Stock Options As Explained by An English Major, Pt. 3


Part Three of a three-part series wherein I, an English Major, explain incentive stock options and how they work for employees at startups. Here is Part One and Two!


Selling it.

 

Now once you’ve bought the stuff — ahem, exercised your options — you’ll have to worry (“worry”) about selling it. Every situation is different. If the company gets acquired, that typically means your shares were automatically sold to the company that bought you. You send in your stock certificate, they send you a bunch of money (or shares in their company, which you can turn around and sell for money, or so you’d hope). If the company IPOs, well, I have no experience with that but I imagine you just sell your shares on some website like everyone else.

If your company is still private, though, you can often sell the shares on the “second market”. There are also websites for that, but the company may need to approve the sale. Sometimes they make you sign something that says you can’t sell it without their permission. Or that you can never sell it! That kind of sucks, though there are all kinds of reasons for them to do it that are in the best interest of the company (if not in your own personal best interests, i.e. cash money).

Even if not, private companies usually have something called the right of first refusal. That means if you come knocking with a dentist or a rich uncle or somebody who wants to buy some of your shares, the company in question can say, “Actually no we don’t want this guy owning part of our company and pestering us about weird shit or even voting on big issues, so we will just pay you whatever that guy was willing to pay you and buy your shares back from you.”

If you own shares in any company, public or private, “holding” these assets (i.e., not selling them) for over a year gives you a tax advantage. It means that when you do sell, the profit will qualify as a long-term capital gain rather than ordinary income. You’ll be taxed at say, 15% vs. 35% (depending on your tax bracket).

Yes, this is what’s wrong with America but what can you do. Vote, I guess. Pay extra taxes? Ha! (Do people do that?)

If you have to sell before the 12-month holding period, the net gain (what you earn minus your strike price), also known as the bargain element or spread to get all jargon-y on you, will be considered a short-term capital gain. That means it will be treated as ordinary income by the IRS and your employer will get a tax deduction and you’ll have to pay 35% or 38% or whatever your tax rate is. This is somewhat devastating but in the spectrum of Bad Things, paying slightly more taxes, yet still less than you should if we ever want to have a functioning government, is not all that bad. Things are going pretty well for you overall so maybe smoke a cigarette, say “Fuck everything,” a few times and then own your shit and do what you need to do.

People sell their shares the same year they exercise them fairly often, usually because their exercise triggers the dreaded, aforementioned AMT, wherein you have to pay taxes on shares you buy before you even sell them, and they need money to pay it. And yes, in this case you’re essentially selling shares to have money to pay the taxes on buying them. Avoiding this situation is ideal, but sometimes unavoidable. In which case, hey, it’s all free money you barely deserve anyway. Throw it back at the government, think of all the drones potholes you’ll fix. Or at least that’s what I tell myself.

 

TIP: Whatever your situation, don’t forget about state taxes, lest you end up sitting on your couch with your tax printout, crying and feeling like a Libertarian. New York charges 8%. New Hampshire 0. Just something to think about.

 

ANOTHER TIP: This is the basest, most abstract and gargled explanation of tax implications for buying and selling stock options imaginable, simply meant to help you wrap your head around this shit. For the love of god, do some more research and get professional help.

 

 

By the time I was debating about whether to sell some of my shares on the second market, I had met with relevant people a few times, and at least one of whom had generously mentioned things offhand like, “Now you’ll want to hold onto these for a year,” and I knew enough to take it to heart (and to Google).

I was too overwhelmed to even think about selling for at least a year, anyway. I’m not sure what got me thinking about selling at all, my plan was just to wait until the company was acquired or went public, and let the financial shit happen to me. I wrote to a former coworker and we finally talked about the whole stock thing and I realized that while I was busy feeling weird and avoiding the whole thing, other people were being smart and looking after themselves financially the whole time. I just hadn’t asked anyone about it. Oh.

When the year-long holding period did pass, I thought about how nice it would be to pay off my student loans in one fell swoop. And how nice it would be to hedge my bet a little. It was the only stock I owned, and while I didn’t know much about the stock market I knew that businessmen in movies and editorial cartoons were always shouting, “Diversify!” so that had to mean something.

I asked someone who knew about this stuff to get coffee with me, where I sat all hunched over and told him I felt weird and was a general shame to my gender.

“Wait, what are you talking about you ‘feel weird’? What does that mean? Why would you ‘feel weird’?” ← money guy

What I meant was: if I try to sell some of my stock, am I saying I don’t have faith in this company? Am I saying I think this is the best I can get? Am I being greedy? Am I causing trouble? Will everyone hate me? Am I jinxing myself?

What I actually said: “I don’t know! I just feel weird! I feel bad. I don’t know. I just do. It’s weird!”

How I yearned to trail off at the end of sentences with a, “Well, you know what I mean.”

Instead I had to learn to articulate feelings about money, and get over feeling stupid, and learn how to ignore the part of my brain that said, “this isn’t your thing, you don’t know about money, you’re an English major, this was never meant to be happening to you!”

“There’s nothing to feel,” my coworker told me. “This isn’t an emotional thing. This is business.”

That is when something in me shifted. Possibly not something I wanted to ever have shift – the wheels of capitalism. But still. It’s business! My business, whether I liked it or not. I thought of the Godfather, or the Godfather as referenced in You’ve Got Mail. It was a freeing thought, and while I’m still not sure I fully believe it, I know the other guy does, so I vowed then and there to study up.

When I did eventually pull the trigger and sell 20% of my stock options to a seed fund on Sand Hill Road, the whole thing took nothing more than a few phone calls and a fax I must have had to resend five humiliating times. When the money was deposited in my bank account I whelped out loud at my desk and took a nervous lap around the office.

Then I paid off my loans, joined the CSA, opened an IRA, and bought a couch.

The man who used to be my boss, the one who gave me my first option grant, who told me it’d buy me an apartment one day, who warned me about AMT and long-term capital gains, and who slid a calculator across the table at a coffee shop to show me what my stock was worth, years later — he emailed me to wish me well and to say congratulations. I told him I was going to pay off my student loans, and then some. “Great,” he said, and then, “You earned it.”

Deep in me I know this isn’t true, that I didn’t earn it, not hardly, but am warmed by the generosity of the sentiment. He must know, too, it’s a thing we all want to believe but deep down don’t.

Not that I’m complaining.

---
---
---
---
---
---

11 Comments / Post A Comment

sarahsayssoo (#4,237)

The idea of earning these types of compensation is one I am struggling. My company gives everyone carried interest in our funds and I keep thinking of it as a gift in my head. Like I shouldn’t say anything about the percentage I have, it’s just a gift so complaining would be tacky, etc. But that isn’t really true. We work hard and this money (or really, possible future money that may or may not exist ever)is part of what we earn.

@fo (#839)

Hey Meaghan, I think it’s more common to call it “the secondary market”. See: http://venturebeat.com/2012/09/20/secondary-market/

“Second market” mostly points to “SecondMarket”, a broker (slightly oversimplified) of secondary market transactions for private (mostly pre-ipo) companies.

Meaghano (#529)

@@fo Ha, oh yes. Duh. God bless you.

WayDownSouth (#3,431)

Well done Meaghan. Now that you’re close to 30, own some assets and will be financially responsible for someone other than yourself, I look forward to reading about you moving toward the right side of the political scale over time…

madrassoup (#929)

@WayDownSouth I can’t decide whether to respond to your condescension (“well done Meaghan” — for what? Writing the last part in a series while on vacation?), or your conviction that anyone above a certain age who has money and children is/should be conservative. So I’ll just settle on: I know you mean well, for the most part, but you are such a pill sometimes.

Markham (#1,862)

@WayDownSouth I was liberal when I was in my early 20s and broke….

…now I’ve been in Management Consulting in the tech world for 10-yrs, and while I hate may tax rate…

…more liberal now.

So, nice try – lot’s of people with money are liberal. Obama won all the highest earning states :)

WayDownSouth (#3,431)

@madrassoup I don’t recall asking for your opinion of my character, but I’m glad that you took time out from your busy schedule to provide it. Thanks for sharing.

Eric18 (#4,486)

@madrassoup I don’t think WayDownSouth was being condescending at all. You on the other hand, talking to him by saying, “I know you mean well….”

honey cowl (#1,510)

@WayDownSouth Oh my god.

Markham (#1,862)

I’m confused by the sentiment that you didn’t “earn” or “deserve” the stock options.

The value of your labor to a company is always worth significantly more than what they pay you for it, this is especially true for people in white collar professions and as you work your way up the ladder.

Basically whatever you were paid in benefits, salary and the options was definitely worth less than the value of your contribution.

In my own experience where I’m in a situation where I actually have to justify the financial impact of my work on the company, the value of my contribution is HUGE compared to what I get paid, I mean I get paid very well, but still….

If anything, options are great as they spread the wealth around.

Anyway, glad this worked out for you! Every time I’ve gotten options they wound up being worthless :(

-M

jalmondale (#6,721)

This so accurately captures my experience with start-ups and stock options, and feeling kind of awkward about the rather large sum that showed up in my account. I’d just add that, assuming you remain on good terms with the company after you leave, you would be surprised how much they might bend the rules for you. For example, it’s fairly common for the place I left to extend the 90 day exercise rule to 3 years in exchange for giving them more veto power over when you sell, but I had no idea it was an option until I happened to have coffee with one of the finance guys. With that sort of (potential) money on the line, always ask! The worst they can say is no.

Comments are closed!