So, are you finally ready to exercise your options, become a shareholder and start the 12-month long-term capital gains holding period? If so, that’s something to be excited about! It’s a relatively straightforward process, but there can be pitfalls along the way. Here are three things to watch out for to keep your journey to becoming a shareholder on-track.
Changes in Fair Market Value
The fair market value (FMV or 409A value) of a company’s common stock is typically established by an independent valuation firm and impacts the amount of taxes due on your options. Depending on the maturity of your company, the FMV may be updated yearly, quarterly or monthly. When the capital markets recover, FMVs could begin to rise too. This means an increase in your tax burden when your options are exercised, which could result in being short of cash to fund your exercise, or your financial partner having to change terms to accommodate the increased FMV. Regardless, exercising when the FMV is lower is generally preferable, so you may not want to wait if the opportunity presents itself.
Beware of Exercise Blackout Periods
Exercise blackout periods are usually associated with a new FMV or capital raise and prevent you from completing an exercise. They vary in length from a few days, to upwards of a month, which can torpedo your plans to exercise your options. Sometimes blackout periods are communicated ahead of time, but they can also be immediate and unannounced. This means two things: 1) you won’t be able to exercise your options on the date you planned to, and 2) once the blackout period is lifted, the FMV will most likely change. If you are on a short time frame due to a pending company departure, or perhaps the amount of cash you have to fund your exercise is constrained, this can potentially wreak havoc. We encourage option holders to check with their equity plan administrator as soon as they are considering exercising to see if there are any blackout periods on the horizon and if not, strike while the iron is hot to prevent any unwelcome surprises.
Impending Expiration Dates
A less frequent, but no less frustrating, occurrence is having your options expire during the post-IPO lockup period. The post-IPO lockup generally lasts 180 days after the effective date of the company’s registration statement (although this can vary). This period is a strict block of time where, despite being publicly traded, shares cannot be sold by current or former employees – not even to fund the taxes of an option exercise (i.e., a cashless exercise). This is something we have encountered more recently as companies stay private longer. Lockup agreements are unforgiving to option holders, so it is best to keep an eye on your options expiration date. Whether a pending expiration is a result of the 10-year option lifetime, a post-termination exercise window extension granted by the company, or the typical 90-day post-termination expiration, you will want to keep that timeline in mind and avoid any overlap with a post-IPO lockup.
ISO Season is Upon Us
Lastly, if you have been putting off exercising your incentive stock options (ISOs), January can be a great time to do it. This is because taxes on ISOs are typically not due immediately. Please consult a tax advisor or CPA for your particular situation, but taxes on exercise of ISOs may only need to be paid quarterly or not until April of the following year (i.e., Tax Day). At Liquid Stock, you only have to draw the money you need, when you need it, which can save on costs. If you are considering exercising your ISOs, get in touch with our team today to learn more about our option-exercise solutions.
This blog post is intended for general informational and education purposes only. Liquid Capital Management, LLC (together with its affiliates, “Liquid Stock”) makes no representations as to the accuracy of information in this post, and no representations or guarantees as to specific outcomes from relying on this post. No content in this post is intended or should be construed as tax, investment, legal or accounting advice by Liquid Stock, or as an offer to sell or solicitation of interest to purchase any securities offered by Liquid Stock. Liquid Stock does not provide tax or other financial, legal or regulatory advice to its transaction counterparties. Always consult with your investment, tax, and legal advisors before making important financial decisions. The terms of any Liquid Stock transaction may vary. Outcomes (including financial and tax outcomes) of any transaction will depend on factors including the timing and value of any liquidity event. While reasonable steps have been taken to ensure that the information herein is accurate and up to date, no liability can be accepted for any errors or omissions. All views and information contained herein are as of the date hereof and subject to change. Information contained in third-party links has not been independently verified by Liquid Stock and inclusion of such links should not be interpreted as an endorsement or confirmation of the content therein. Prospective investors considering an investment in a Liquid Stock fund should not consider this content as fund marketing material.
