How to Pay for Your Options

If you work at a private company, your compensation package may include stock options. If the business is performing well, this opportunity to gain equity can offer a path to significant financial reward. But when the time comes to “exercise” those options — to convert them from a right-to-buy into actual ownership — many employees face the dilemma of how to pay for it.

Whether your stock hasn’t vested yet, or all of your options are ready to be bought, it’s important to think about if — and how — you’ll choose to exercise your stock options.

Understanding the Upfront Costs

The first number you need to consider is the “strike price,” which is the amount you’ll pay to purchase one share of your company when you exercise a stock option. That amount is set when you receive your initial stock option grant, and it will always be the same, regardless of whether you exercise immediately or wait several years, or if the company’s value rises or falls.

On top of paying the strike price, you’ll need to understand the tax implications of exercising. These taxes vary based on whether the type of stock you’ve been awarded is an incentive stock option (ISO) or non-qualified stock option (NSO), and if your company’s fair market value has increased since you were issued the options. Determining this number can be tricky, so it’s worth consulting with a tax advisor.

How to Convert Your Options into Shares

Once you’ve decided it’s the right time for you to exercise your options and you’ve worked out how much it will cost, there are four main ways you can pay for it, even if you don’t have the money upfront.

Option One: Cash

The simplest way to exercise your options and gain equity in your startup is to use your own money and follow the steps in your company’s stock option administration platform to purchase your shares.

The biggest benefit to this approach is that you own all your shares outright. That means you won’t have to deal with paying back a loan or making interest payments while you wait for an exit. The risk is that if your company underperforms and the value of your stocks goes down, you’ll likely lose your investment, and you’ll have missed out on the gains you could have made by investing elsewhere.

Option Two: Traditional Loans

Traditional loans, like a personal loan or home equity line of credit, are also known as “recourse loans.” Many people take out these loans for their startup equity because they believe that their stock value will go up, and they feel comfortable paying a set interest rate to their lender in the meantime.

Choosing this option means that you don’t need to commit a substantial amount of your own money to exercise your stock. As a result, you can invest it elsewhere — in the public markets or into property, for example. It also carries a lot of risk. If your company fails or its valuation goes down, you’ll be on the hook for the amount of the loan, and you may have paid a significant amount in interest.

Option Three: Non-Recourse Loans

Non-recourse financing lets you fund your exercise through a loan, but your shares are the only collateral. Unlike traditional loans, if your company’s value declines or the business goes under, the lender can only pursue the value of your shares. That means your personal savings, investments, property, and other assets are protected.

The obvious benefit to funding your startup equity through non-recourse financing is that you don’t have to risk your own money when you exercise your options. If the company underperforms, the lender will absorb any losses beyond the value of the shares. If the business achieves a successful exit, though, the lender will likely take a portion of the upside, meaning that you’ll potentially reduce your profit. Bear in mind, though, that it can be tough to secure a non-recourse loan.

Option Four: Secondary Platforms

If you want to exercise your options with the goal of selling them (rather than holding them), you might not need to take out a loan or have the cash upfront to fund the exercise. If your company is performing well and has a high valuation, private market investors may be willing to purchase your equity. You can find these buyers for your stock on investing platforms like Mirai Capital.

To sell your shares, you can either exercise them using the three methods above and then place a sell order on Mirai Capital, or take part in a “cashless exercise.” This choice, also known as a “simultaneous exercise and close,” allows you to exercise and sell your options at the same time, where the proceeds of the sale are applied to the option exercise. That means that you don’t have to front any money yourself.

The obvious benefit to selling your stock on a secondary market is that — if you’ve done your math correctly — you’re guaranteed to see a return on your stock options. That means you can meet your financial goals on your terms and on a timeline that suits you. Bear in mind, though, that not all companies allow their shares to be traded or permit a cashless exercise.

What to Do with Your Stock After Exercising Your Options

Option One: Hold On to It

You can simply keep your shares. Many people do this, with the hope that the company will grow and the stock will become more valuable over time. If your company does well and eventually goes public through an IPO, you can sell your shares on public stock markets. Remember, though: if the business experiences a decline at any point or closes its doors, the value of your stock will likely drop or become worthless, too.

Option Two: Sell on Secondary Platforms

An institutional-grade investing platform like Mirai Capital pairs you with a buyer to sell private stock. On Mirai Capital, you can see historical price data, which gives you visibility into what the value of your shares might be. You can anonymously say how many shares you want to sell and what price you’re hoping to get, and if it matches interest from an investor, you’ll be able to send an offer to the buyer, or counter if the price is below your target price.

Selling on a platform like Mirai Capital can give you a chance to get cash for your shares before your company goes public or is acquired. It’s a way to unlock the value of your hard-earned equity sooner and through a centralized and transparent process.

Option Three: Traditional Brokers

You can also use a traditional broker to sell your private stock. Well-connected individual brokers or firms have existing relationships with buyers who operate in the private equity markets, and they can sell your stock through their networks.

Working with a broker, though, gives you less transparency compared to an online investing platform. It might not be clear how they decide on the price for your shares, and it’s harder to see what others are paying for similar stock. Some brokers also charge very high commissions.

Option Four: Tender Offer

A tender offer is a formal proposal made by your company or an investor to buy your stock. Companies usually manage tenders themselves or in partnership with a team of experts like those at Mirai Capital. The offer is typically made for a limited time and at a specific price per share, and may be open to certain categories of shareholders (current employees only, for example) or limit the proportion of shares you can sell. Participation in a tender offer is generally voluntary, which means you can review it and decide whether you wish to sell your shares at the proposed price.

The downside is that it’s up to your company to decide if they would like to make a tender offer, and you also don’t have any control over the timing of the process. That gives you less flexibility to sell your shares at a time that works for you, to pay for life’s big moments.