The table doesn’t make much sense to me. If the strike price is $1 for options on 100,000 shares, then my understanding is that the “Cost at exercise” column will be $100,000 no matter when you exercise. Am I missing something?
Instead, I think it needs a another column for additional gross income for purposes of tax liability in year of liquidation. As I understand it, when you exercise your options at $1.20, you must pay $100k to exercise, then you own taxes on the $20,000 in gains. When you exercise at $20, you must again pay $100,000 to exercise the options, and also pay taxes on the $1,900,000 in gains.
And this fact is what causes early employees to walk away from so much money. There's a huge difference in viability of paying the tax bill on $20k of income vs. $1.9MM when the underlying assets are illiquid, and cannot be sold in part to cover the bill.
Most people will be able to come up with another $6,000 or so to cover the taxes from an early liquidation. But it's substantially more difficult for most to come up with the $500,000 to cover the tax liability in the second case.
Wait, so I can't exercise in July, get the money, and then pay the tax bill in February of the next year?
But, if the company is still private, what you can't do is sell some of those shares that you just exercised in order to cover the tax bill. That's fine if you exercise at $1.20, since that $100,000 exercise only increases you taxable income by $20k. But when you fully exercise at $20, your taxable income for the year increases by $1.9MM.
Most people in that situation can't afford to cover the taxes, so they walk away.
I'm sure the government would have a lot more paperwork to do holding onto all these random shares, but the benefits from simplifying and de-risking equity offers would outweigh that many times over.