Employee Stock Options FAQ

The best time to receive a stock option grant is when the company's 409A valuation (fair market value) is lowest, because the strike price will be set at this value. Lower strike prices mean more potential profit when you eventually exercise and sell.

Optimal timing includes:

• Immediately after company formation when the 409A value is minimal (often $0.01-0.10 per share)
• Right after a 409A valuation is completed but before the next one (valuations are typically valid for 12 months)
• Before major milestones that would increase company value such as funding rounds, product launches, or significant customer wins

If you're negotiating a job offer, ask when the company expects its next 409A valuation or funding round, and try to have your grant approved before that event. However, don't delay joining a company significantly just for timing - the value of getting started and vesting may outweigh a slightly higher strike price.

Several exercise strategies exist, each with different risk/reward profiles and tax implications:

• Early exercise: Purchasing shares before they vest (if the company allows it), combined with an 83(b) election, to start the capital gains holding period early and minimize taxes when the spread is low
• Exercise and hold: Exercising options and holding the resulting shares, betting on future appreciation and qualifying for long-term capital gains treatment
• Same-day sale (cashless exercise): Exercising and immediately selling all shares, realizing the gain without any out-of-pocket cost but with ordinary income tax on the full spread
• Sell-to-cover: Exercising options and selling just enough shares to cover the exercise cost and taxes, holding the remaining shares
• Net exercise: If available, the company withholds shares equal to the exercise cost and taxes, delivering only net shares

The best strategy depends on your financial situation, tax bracket, belief in the company's future, and whether you can afford the exercise cost and potential taxes.

The Alternative Minimum Tax (AMT) is a parallel tax system designed to ensure high-income taxpayers pay at least a minimum amount of tax. ISO exercises can trigger AMT because the spread at exercise (fair market value minus strike price) is an AMT preference item - it's added back to your income for AMT calculation purposes even though it's not taxed for regular income tax.

How AMT works with ISOs:

• When you exercise ISOs, the spread is added to your AMT income
• If your AMT liability exceeds your regular tax liability, you pay the higher AMT amount
• AMT rates are 26% on the first $220,700 (2024) of AMT income above the exemption, and 28% above that

AMT planning strategies:

• Exercise ISOs when the spread is small (early in the company's lifecycle)
• Spread exercises across multiple tax years to stay under AMT thresholds
• Exercise only enough shares each year to avoid triggering AMT
• Consider exercising in years with lower regular income

Important: AMT paid on ISO exercises creates a credit that can be recovered in future years when regular tax exceeds AMT. This credit can take many years to fully recover. Consult a tax professional before exercising significant ISO positions.

An 83(b) election is a tax election filed with the IRS within 30 days of receiving restricted stock (not options themselves, but stock received through early exercise or restricted stock grants). It allows you to pay taxes on the stock's value at grant rather than when it vests.

For early-exercised options, the 83(b) election:

• Locks in taxes at the current (presumably low) fair market value
• Converts all future appreciation from ordinary income to capital gains
• Starts the capital gains holding period immediately
• Creates risk if you forfeit unvested shares (you cannot recover taxes paid)

When to file an 83(b):

• When you early exercise options and the spread is zero or minimal
• When you receive restricted stock at a low valuation
• When you expect significant company value appreciation
• When you can afford to lose the tax payment if shares are forfeited

When NOT to file: When the current value is high, when you're uncertain about staying through vesting, or when you cannot afford the tax payment.

The 30-day deadline is absolute and cannot be extended. File via certified mail with return receipt, keep copies of everything, and include a copy with your tax return.

Evaluating stock option offers requires understanding several key factors:

Essential information to request:

• Number of shares offered
• Current 409A strike price
• Total shares outstanding (fully diluted)
• Latest preferred stock price and valuation (if available)
• Vesting schedule and cliff
• Exercise window after departure
• Option type (ISO vs NSO)

Calculate your ownership percentage by dividing your shares by total fully diluted shares. A grant of 10,000 shares means little without context - it could be 0.1% or 0.001% depending on the company.

Model potential outcomes at different exit valuations: at a $100M exit, 0.1% ownership (after any liquidation preferences) would yield $100,000 before taxes. Consider realistic exit scenarios, not just the best case.

Compare to market data using resources like levels.fyi, Glassdoor, or Option Impact benchmarks for your role, level, and company stage.

Factor in the exercise cost and your ability to pay it, especially if you might leave before an IPO.

Stock option treatment in acquisitions varies based on deal structure and your option agreement terms. Common outcomes include:

• Acceleration: Single-trigger acceleration vests all options upon acquisition; double-trigger requires acquisition plus termination or role change (more common)
• Assumption: The acquiring company converts your options to their stock at an adjusted ratio, and vesting continues
• Substitution: New options are granted with equivalent value
• Cash-out: Options are converted to cash payments equal to the spread (acquisition price minus strike price)
• Cancellation: In some cases, underwater options (strike price exceeds acquisition price) may be cancelled with no payout

Important considerations:

• Review your option agreement for change of control provisions
• Unvested options may be forfeited if not assumed or accelerated
• Tax treatment depends on whether you receive cash, stock, or continuing options
• The acquisition timeline affects whether you can exercise before closing

If you have advance notice of an acquisition, consider exercising vested options before closing to potentially receive stock (and defer taxes) rather than cash.

The post-termination exercise period (PTEP) is the window after leaving a company during which you can still exercise vested stock options. After this window closes, unexercised vested options are forfeited.

Standard PTEP terms:

• ISOs must be exercised within 90 days to maintain ISO tax treatment (IRS requirement)
• Many plans set 90 days for all options, though some companies offer extended windows
• Some companies now offer 7-10 year exercise windows as an employee benefit
• ISOs exercised after 90 days convert to NSOs, losing favorable tax treatment

PTEP matters because:

• Exercising requires cash for the strike price and potentially taxes
• You must decide whether to exercise without knowing the company's eventual outcome
• Short windows create pressure to exercise or forfeit valuable options
• Many employees forfeit valuable options due to short exercise windows and cash constraints

Questions to ask when evaluating offers: What is the post-termination exercise period? Does it differ for voluntary vs involuntary termination? Does the company offer extended exercise windows?

Refresh grants and promotion grants are additional equity awards given to current employees beyond their initial hire grant.

Refresh grants (also called evergreen grants) are periodic grants given to employees to maintain competitive equity compensation as initial grants vest. Typically awarded annually after the first 1-2 years, they may be based on performance reviews, level, and tenure. The goal is to ensure employees always have meaningful unvested equity as a retention incentive.

Promotion grants are additional equity awarded when an employee moves to a higher level. They bridge the gap between current holdings and typical equity for the new level, and usually come with a fresh vesting schedule (often 4 years).

Typical structures vary by company stage:

• Early-stage startups may offer larger refresh grants as equity is the primary compensation lever
• Growth-stage companies typically have more structured annual refresh programs
• Public companies often use RSUs for refresh grants with more predictable value

Negotiating additional grants: When promoted, research equity levels for your new position. If your initial grant is mostly vested, negotiate for a meaningful refresh. Consider timing - ask during strong performance reviews or when you have competing offers.

Refresh grants typically vest on a new 4-year schedule with a 1-year cliff, meaning you need to stay another year before any of the refresh vests.