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I'm exercising my ISOs on Monday

I'm exercising my ISOs on Monday

Today is exercise day

Good morning everyone. Monday is a BIG day for me, and a big day for my investing strategies going forward. I'm exercising around 1/4 of the options I've been awarded in the startup I am working for. Although this won't have a huge impact for me in the near term, over the course of the next 3-4 years I am hoping this single decision will save me thousands of dollars (or if I am really lucky, tens of thousands) in taxes. This may also be the only tranche of shares I purchase in a tax advantaged fashion; I'll go into detail on that later.

More importantly, I'm now officially an OWNER of the company I am working for... albeit a tiny minority owner... but still an owner. I may work for the man, but I am also benefitting more directly from the effort I put into the daily grind as well.

The numbers

As I have detailed quite recently, knowing when to exercise ISOs (incentive stock options) is absolutely critical. The general principal is to exercise as much as possible as early as possible, but only if the value of the company will be guaranteed to rise in the future. Going outside of those bounds too far can easily result in some truly terrifying tax implications. 

At the same time, exercising early is an incredibly important step to reducing the tax liability of incentive stock options. The difference in value between the strike price of the options and the price of the stock at exercise is taxed as income, and all of the gains after that are taxed as capital gains (as long as the stock is held for more than a year). Here's how the numbers are working out for me. To be frank, I am faking the share count to maintain some level of privacy, but the share prices are very close to reality, so the math is correct even if the magnitude isn't.

Grant details

  • Grant Date: 2/1/2017, 1 year cliff, 25% per year vesting monthly

  • Shares Granted: 4,800

  • Vested as of 3/1/2018: 1,300

  • Strike price: $4.00

  • Current price: $8.00

  • Cost to exercise: $5,200

  • Value at exercise: $10,400

As you can see, the price of my stock has doubled this year, which is incredibly encouraging. I should say that we are still a ways away from an IPO, so it's impossible to know where the company will go from here, but I am very confident my shares will be worth at least $18 a share when we IPO, or on the off chance we are bought. Possibly more.

If I exercise now, I am only going to incur $5,200 ($10,400-$5,200=$5,200) as income. If I wait until we IPO and the price is at or above $18 per share, it would be more like $18,200 ($23,400-$5,200=$18,200).

Without going into the math too much, that means that I am lining myself up for a 40% reduction in my taxes.

The shares I buy now will be taxed at long term capital gains (15%~) from the current value to value when I sell. This comes out to around  $3950 in total taxes (($18 sale price -$8 current price)*(1300 shares) * .15)=$1950 + approximately $2000 in taxes due on the difference in strike and exercise since I am exercising now. That is compared to a roughly 35% tax rate if I don't buy now, which would amount to $6370 in total taxes (($18 sale price -$4 purchase price)*(1300 shares) * .35). $6,370-$3,950=$2,420 in savings on around $24,000 total - NOT BAD! The savings only get more attractive the higher the stock price goes.

This is probably my only early purchase

Truthfully, this is probably the only exercise and hold I am going to do. I am fairly confident that our company will be privately valued above $12 or $15 a share this year, leading to a very small margin of potential gain if we IPO at $18 as I expect. Now, things could go much better than I expect, but I don't want to put myself in a position where I have to sell my shares at a loss to pay my taxes. It's a give and take. 

One last thought

As you can see, I am excited about the tax savings, but for me this is much more meaningful in another way. I've always wanted to be an entrepreneur of some sort, and truthfully I've never really done anything that entrepreneurial. Owning shares in the company, even if it's just a little, makes me feel like I have some hand in it's future, and that I stand to more directly gain from it's growth beyond my day to day salary. If I'm not an entrepreneur yet, at least I am an OWNER. I'll never work for a company where that isn't part of my employment. 

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