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Comment by tvladeck | Hacker News Reader

Regarding the fact that the employees had to pay tax on what turned out to be worthless shares:

They could have avoided this by waiting to exercise their options on the eve of the liquidity event. In this case there would have been no risk. But they exercised earlier presumably to start the clock on long term capital gains treatment for the stock they received when they exercised.

They took risk they didn't need to take and they got burned. It's worth keeping that in mind as another aspect to the story.

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You can't presume that they exercised early voluntarily. If you leave the company, you typically have 90 days to exercise options or they are forfeited back to the company. In other cases, they actually just expire after enough time passes, which again forces employees to exercise before a liquidity event.

Fair point. I did make that assumption.

Again though nobody forced them to exercise. It accelerates the timeline, but it's not forcing anyone into anything more than having to make a decision.

Typically, when you leave a company that issued you incentive options, you are forced to execute within 90 days or forfeit the shares entirely.

To your point though, and to press it further - if companies require that you exercise your options in a window after they vest or they expire - they were never really options to begin with. In essence, the vesting schedule on expiring options is a timeline for you forking over risk-filled cash or forfeit part of your "compensation."

The advice seems to suggest if their options expire if you don't buy them at a certain point (except for leaving the company, which makes sense), say no and ask for cash. If they can't pay, now you know where you really stand.

This is often repeated wisdom, and it is quite wrong.

If the liquidity event involves the public stock market in any way e.g. IPO, merger, acquisition with a nontrivial part of the proceeds paid in shares of a public company - then you are forced to execise on one hand, and have a lock-up period, usually 6 months, forced by the underwriters or SEC rule 144.

That is, there is a mandatory 6 months wait between the forced exercise and the effective liquidity event.

This applies to investors as well as employees, BTW: I was bitten by this as an investor -- a modest 5X return on investment after 2 years turned out to be less than 2.5X return (still nice), but the taxes were paid on the 5X numbers, and the end result net of taxes was therefore 1.1X -- and it would have been a loss if everything happened in the other half of the year (luckily, I was able to net the gains with the losses because the 6 month lockup was april-october; but had it been october-april, even that wouldn't have been possible).

In two other tax regimes I've operated in, you are only ever assessed taxes in the event you can take money into your pocket. The US system is ridiculously unfair in this sense.

You're making the point that if there were a liquidity event they'd be forced to exercise.

I made the point that they didn't have to exercise when they did, and if they had waited they wouldn't have taken on any risk about the price of the stock they were receiving.

Note how those are not mutually exclusive.

But beagle3's point is that the lock-up period means you still take on risk even if you wait until the liquidity event. Perhaps this is less risk in many cases, but it still isn't zero.

> They could have avoided this by waiting to exercise their options...

The article refers to "stock grants" and refers to the fact that "Top sales employees were awarded with annual bonuses of 20,000 shares of common stock".

IANAL but AFAIK, receipt of stock grants would trigger an income tax liability on the value of the shares at the time they were granted.

Tax treatment of stock grants and options is very complicated and so dependent on details that it seems somewhat unfair to jump to any conclusions based on assumptions which are almost certainly incorrect.

The wider the gap between the exercise price and the fair market value the more AMT you will owe on the shares when you exercise. By making a speculative investment -- by exercising early -- you will owe minimal AMT at exercise time and more capital gains later when you sell.

There are very real tax advantages to exercising early.

If you really believe in the company and it's a rocket ship (some rockets explode mid-flight or stall though!) then I'd recommend buying some shares early on to hedge for the reason you state. But I probably would't early exercise 4 years of options on your first day at the company.

Some companies sell part of your stocks (on your tax level) to pay tax in your country as soon as the options vest without your say.

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