Would you or would you not exercise your stock options in this scenario?

Question details (original on Quora)

  • My strike price is $650, and the current fair market value is $1250
  • I must exercise my stock within 3 months from when I leave the company next week
  • The company won’t tell me how many shares are outstanding
  • The company is likely to go public (let’s say 70% probability) in the next 1-2 years at ~$10B IPO. I’d say the likelihood of an acquisition is pretty low.
  • Exercising all of my stock options would be a significant investment compared to my current savings, but if I were convinced this is a smart risk to take, I’d go all in
  • My stock does not meet the minimum requirements on secondary markets like Sharespost, so I’d only get a return at IPO or acquisition

Basically my question is: how do I calculate the expected return of my stock?

Answer, by Dan Walter

This is a more nuanced question than many people may imagine. There are certain things that truly are important to know before you make this decision.

1. Shares outstanding. While others have said this is not important, it is actually critical. Currently companies in strong IPO tend to have an IPO price of between $15 and $18 per share. Given your strike price the company likely has far fewer outstanding shares than it will have at the time of IPO.  This is probably a good thing. You will likely end up with far more shares after the split (lower price = more shares since total value won’t really change).  To get to a price of $17 given todays price of $1250 you would have to multiply the outstanding shares by about 73.5 times.  Since we have no idea how “accurate” the current value is, it would be hard to provide great advice on this point.

2. Rules regarding your grant.  Can the company buy back your VESTED and EXERCISED shares?  If so, at what price?  While this is not common, it has happened at some high profile companies over the past decade.  You may find yourself spending your money, then simply getting back in a couple of years.  You may have to write off losses and deal with the lost time-value of your money.  Without fully understanding your plan details, it is hard to know how this will work.

3. You haven’t mentioned whether you have ISO or NQSO stock options.  If you have ISOs then you won’t be paying taxes at the time of exercise, but there may be an issue with AMT if something great happens with the company before the end of the year.  With NQSOs the spread (right now $600 per share) will be taxed as ordinary income.  This will be paid at the time of exercise, and likely via withholding by the company.  They may allow you to have some of your vested shares withhold to cover the taxes, but more likely they will require you to add around 40% to the total exercise cost.

4. An IPO two years out is unlikely to be a 70% probability.  There are, of course, exceptions to this rule of thumb, but if the IPO is planned and being worked on for execution within the next 12 months, I would lower your expectations.  A lot can happen in 2 years…

And with all of that being said… You have options that are already almost 50% in the money.  It sounds like you have enough of them to make the exercise a burden, but perhaps not a life changing risk. If you had 500 stock options exercisable you would be looking at an exercise cost of $325,000, plus taxes due (assuming an NQSO) of around $120,000, having a value of $625,000.  So a net value at the time of exercise of $205,000.  Of course we have no real idea of the potential future vaue since we have no idea of the current company value. A $10B value in two years won’t mean much if today’s value is $7.5B.

I hope this gives you some good information to ask the company some specific questions.