Are you wondering whether you should buy your stock options after leaving a startup? This article will address whether you should or not. For background, I did buy my stock options when I left my startup after three years. It worked out well.
A couple years ago, this one 28 year old woman I knew left a Series B funded company after two years for a higher salary at a large financial institution. She decided not to buy a single one of the many options she had spent two years accruing. At the time, I thought she was crazy because her startup was clearly going places.
Well, I've finally come to realize that perhaps she wasn't crazy. Maybe she really also believed in the trajectory of her startup, but simply didn't have enough money to buy her own shares.
Should I Buy My Stock Options After Leaving A Startup?
After a year of consulting at one firm, I was fortunate enough to be granted some options after asking the CEO whether that was a possibility. He said “yes,” and just like that, an option package was created that granted a certain amount of options to me for every month I worked plus a one time grant for the year that I had just completed.
I basically had to cut multiple checks that added up to a little under $9,000 to buy my options within 90 days after I separated from the company. I did so because I believe in the company's valuation trajectory. In the grand scheme of things, $9,000 isn't a lot of money. But remember, I was a contractor who worked part-time.
Imagine how many more options full-time employees get after a similar duration of work? In order to buy their options, they'd probably have to pay $20,000 – $60,000 on average!
When I sent my envelope with the signed documents for each grant and checks totaling almost $9,000, I also e-mailed the recipient asking her to inform me when she planned on depositing the checks. I never have more than $1,000 sitting in my checking account at any given moment in order to maximize interest returns and control my spending habits.
Five years later, the startup I worked for sold for $850 million to Empower Retirement. As a result, my $9,000 in stock options turned into $49,500. It was a great move.
In other words, even though I have a healthy income, $9,000 is still a meaningful amount for me to pay. Now imagine if you were only making $60,000 – $150,000, like the majority of startup employees do, with student loan debt, and a desire to save as much as possible to buy a house one day? Writing a $20,000 – $60,000 check to buy your options sounds like a difficult task!
Why You Should Buy Your Stock Options
- Holistic View. If you were willing to give up at least a year of your life making a below market salary, then you should absolutely be willing to buy your options when you leave. Options are an integral part of any startup employee's pay package. You don't want to lose out on making less salary and not have options be worth something meaningful in the future.
- FOMO. What if you passed on buying your options, and the options then turned out to be a 10 bagger? You would probably never forgive yourself for making such a bad financial move. It would be like passing to work at Facebook when the firm still had less than 1,000 employees. You might literally cry yourself to sleep every night! Investing FOMO is the hardest type of FOMO to conquer.
- Diversified Portfolio. If you are moving to another firm, you've already secured another income stream. If you're already methodically investing your savings, why not buy your options to create a more diversified portfolio or net worth? After 10 years, you might be able to build a portfolio of 2-10 positions in startups much like a Venture Capitalist would. Add your private positions with your public positions, and you'll have an overall portfolio many people would be proud of.
- Reasonable Percent Of Your Portfolio. If you have a $100,000 investment portfolio, exercising $10,000 worth of options is within a reasonable range. But if you've got to exercise $50,000 of your options, perhaps your risk is too skewed. Unless you really believe the company is a slam dunk, you don't want to have greater than a 1/3rd position in your options.
- High Certainty Of Growth. Startups are usually loss making. But if there is a high certainty of growth with a proven business model that will allow the company to eventually make a profit, then it's probably a good idea to buy your options. You should know better than most how well your company is doing. If you're under 40, you should be investing more in growth stocks anyway to try and build your capital as much as possible.
- An Increasing Amount Of Acquisitions. If you see competitors getting gobbled up by larger companies, your company might be next if its in healthy operating condition. I promise you that big fish are always analyzing whether to acquire smaller fish or grow from within.
- The High Chance Of An IPO. It's pretty obvious that companies like Uber and AirBnB will eventually go public. Companies of this size usually give RSUs vs. options. RSUs are basically stock grants given to you at various anniversary dates. Hence, you don't have to buy your options. But for other smaller companies that are showing similar funding and growth trajectories, it's better to buy your options, even if the final IPO valuation might be lower than previous private funding.
- Low Liquidity Needs. If you've got strong cash flow, or a high level of liquid savings, then it's better to buy your options for all the reasons stated above. You may have to wait for 1-10 years for your options to become liquid, if at all. The need for liquidity is overrated if you are a financially competent person.
- You Can Pay Lower Taxes. You must consider three tax rates: The federal AMT rate at 28%, the ordinary income tax rate that can go up to 39.6% if you make over $400,000 if Joe Biden gets his way. Further, the long term capital gains tax rate of 0% for the 10%–15% brackets; 15% for the 25%–35% brackets; and 20% for the 39.6% bracket. If you are early in the company, can afford to exercise, believe in your company, and hold on for at least one year, then you can pay the lower LT capital gains tax rate.
Reasons Not To Buy Or Exercise Your Stock Options
The reasons against buying your options are basically the opposite of all the above. But the main two reasons for not buying are as follows:
- You Can't Afford To. You generally have 90 days once you leave the company to buy your options. If the choice is between buying an option lottery ticket or paying your rent or your student debt, then you probably will have to pass on buying your options unless you can get a nice loan from your parents.
- The Company Is Failing. There's no use throwing good money after bad. If you're leaving your company, chances are that you no longer believe in the company anymore. Perhaps growth rates are slowing precipitously, or management has extended its breakeven forecast one too many times, or perhaps it's become clear that larger, better-funded competitors will eat your lunch. After all, most startups never have a good exit.
Stock Options Are Usually A Lottery Ticket
The ~$9,000 position at this startup will be catalogued under my private equity investments portfolio. My hope is that the $9,000 will turn into a realistic ~$30,000 in three years. It's not a significant amount of money, but if I look at the position as a part of a larger portfolio, it's better than a poke in the eye.
The funny thing about my $9,000 investment is that it turned into $49,600 five years later when Personal Capital was sold to Empower Media in 2020. Not bad! Now I wish I was able to have bought $50,000. That would have been really sweet.
I cannot emphasize enough that for a large majority of people, joining a startup won't make you as wealthy as joining an established firm due to the significant base salary differentials. Established firms often pay 30% – 100% more than startups, while also providing year end cash bonuses as well. Therefore, my bias is for employees to buy their options if it's clear their company isn't going in reverse.
Startup Life Is Treacherous And Underpays
According to Glassdoor, the median pay at Netflix, a public company, is $132,220. The median pay at Uber is only $102,000. A 25%+ differential is significant, as that equals $125,000+ over 5 years. Meanwhile, Netflix stock is liquid and Uber stock is not. There are many more examples where the difference in median salaries is even larger e.g. finance firms vs. startups.
The general rule of only having 90 days in order to buy your options seems quite restrictive. It's good to see some companies like Pinterest have a longer time period for departing employees to purchase. No wonder why so many employees stay at firms longer than they want to, because as long as they are with the firm, they don't have to pay for any of their options.
I like the idea of building a diversified portfolio of private company stock just like a VC. All it takes is one to do really well. But overall, I'd keep your private investments as a percent of your total investable assets to no more than 10%.
For the rest of your investment portfolio, follow my stock and bond allocation by age. Over the long run, you'll be glad you went for singles and doubles instead of lottery tickets.
Finally, obviously you should buy your stock options if the company is going to go IPO or about to raise a huge round of new funding at a much higher valuation. Your returns won't always be positive. But it make be as close to a sure thing in such scenarios.
Invest In Private Growth Companies
Instead of working at a startup or only working at a startup, consider investing in private growth companies through an open venture capital fund. Companies are staying private for longer, as a result, more gains are accruing to private company investors. Finding the next Google or Apple before going public can be a life-changing investment.Â
One of the most interesting funds I'm allocating new capital toward is the Innovation Fund. The Innovation fund invests in:
- Artificial Intelligence & Machine Learning
- Modern Data Infrastructure
- Development Operations (DevOps)
- Financial Technology (FinTech)
- Real Estate & Property Technology (PropTech)
Roughly 35% of the Innovation Fund is invested in artificial intelligence, which I'm extremely bullish about. In 20 years, I don't want my kids wondering why I didn't invest in AI or work in AI after living in San Francisco!
The investment minimum is also only $10. Most venture capital funds have a $250,000+ minimum. In addition, you can see what the Innovation Fund is holding before deciding to invest and how much. Traditional venture capital funds require capital commitment first and then hope the general partners will find great investments.
Recommendation For Leaving A Job
If you want to leave a job you no longer enjoy, I negotiating a severance instead of quitting. If you negotiate a severance like I did back in 2012, you not only get a severance check, but potentially subsidized healthcare, deferred compensation, and worker training.
Since you got laid off, you're also eligible for up to 27 weeks of unemployment benefits. Having a financial runway is huge during your transition period.
Conversely, if you quit your job you get nothing. Check out, How To Engineer Your Layoff: Make A Small Fortune By Saying Goodbye, on how to negotiate a severance.
I first published the book in 2012 and have since expanded it to 200 pages from 100 pages in the latest edition thanks to tremendous reader feedback and successful case studies. Both my wife negotiated six-figure severance packages to be free. Maybe you can do the same!
Manage Your Finances
One of the best way to become financially independent and protect yourself is to get a handle on your finances by signing up with Empower. They are a free online platform which aggregates all your financial accounts in one place so you can see where you can optimize your money.
Before Empower, I had to log into eight different systems to track 25+ difference accounts (brokerage, multiple banks, 401K, etc) to manage my finances on an Excel spreadsheet. Now, I can just log into Empower to see how all my accounts are doing, including my net worth. I can also see how much I’m spending and saving every month through their cash flow tool.
The best feature is their Portfolio Fee Analyzer, which runs your investment portfolio(s) through its software in a click of a button to see what you are paying. I found out I was paying $1,700 a year in portfolio fees I had no idea I was hemorrhaging! There is no better financial tool online that has helped me more to achieve financial freedom. It only takes a minute to sign up.
Related: Don't Join A Startup If You Want To Get Rich: Baremetrics Case Study
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It depends on how the options documents are written. Some options, you need to pay the option price plus 40% of taxes based on valuation price at the time when you leave. It is a lot of money for many people and paying taxes on private investment is a huge gamble.
When you say, “keep your private investments as a percent of your total investable assets to no more than 10%”, is that 10% based on exercise price, reported earnings/IRS price, or valuation in the most recent funding round?
Let’s say I have a $100k portfolio and 100k options with a strike price of 10 cents each. If I exercise these, that’s an exercise price of $10k. Further, let’s say that the company’s most recent SEC filing stated a value of $1/share, or $100k total, and the most recent funding round was $50M with 20M outstanding shares on a fully diluted basis, or $2.50/share for a $250k value.
In terms of asset allocation, which number you choose drastically affects your asset allocation.
* exercise price: $10k/$100k=10%
* filing price: $100k/$190k=53%
* valuation price: $250k/340k=74%
If you worked for a public company and purchased company stock in your 401k / ESPP at a 15% discount, you would still value it at market value rather than your discounted cost basis.
Of course, since there’s no liquidity, you can’t exactly rebalance like you would in traditional asset allocation strategies.
I’m leaning toward using the SEC valuation myself, as it’s a nice middle ground and I have a lot of faith in my former company. (Calculating the expected value with my assumptions on exit timing and valuations yields a nice return.)
Unless you are really sure that the company is going to fail, I think you should always buy as much options as possible. Like you said, see it as being your own one-man VC. With the below average salary they pay at startups this is the only way to compensate. And if you don’t have the money to buy the options you might want to rethink if you have any business being at a startup in the first place.
I think it definitely depends on your views of the company and where you think the company is heading but like you said, a lot of it probably has to do with what it costs to make the purchase.
For me it was a no brainer, my company granted me stock options at a dirt cheap price it barely put a dent to purchase them and now they have grown 3000% to what I have purchased them for. Was really awesome and I got lucky for sure.
30X is great! Can you sell though? Why did you leave? thx
Yes its amazing. I can sell, i am fully vested however I am choosing not to sell. I still work at this company and I like the way its heading so I believe that it will continue going up.
At some point im sure ill cash out and possibly buy more rental properties but for now im letting it grow.
A few months ago, I helped a relative execute a sale of stock options, acquired on a cost-basis of $32/share in 1998. The 1,500 shares cost $48,000 to acquire 17 years ago. The owner/CEO generously purchased back this thinly-traded stock at a price of $203.62/share. While the acquisition was/is a significant amount of money, the risk was very low as the company is diversified (14 separate corporations in this holding company) and all are unglamorous but make money. The taxes on the Capital Gain were just over $50,000, and the value of the exercised options compounded at an 11.5% annual rate (before taxes). So, a great deal as it turned out. For me, as a fly-on-the-wall, the tax implications were quite interesting, as well as the calculations/risk analysis for execution. A good problem to have!
Sexy startups that don’t/can’t/won’t ever make money are horrible bets that will only pay off if the company is acquired. As this article rightly notes, even if the options pay off in the money there is little chance it will make up for the lower salary.
And the bottom line is, the difference between acquiring the options or not is not whatever the gain might have been. Taking this case, investing the $9,000 in an index allows for dividends, potential gains, easy liquidity, and diminished risk. It would be interesting to know what the 28 year-old woman’s stock options might be valued at today, two years later.
Good point on the opportunity cost of investing.
Her options would be worth 3x so far if she bought, and maybe 6x by 2016 bc I know the company is raising at an even higher valuation successfully.
That said, still zero liquidity.
A big issue is folks just not being able to buy their options when they leave, for whatever reason.
I’ve got some options for a private company stock – not for having worked there, but for having invested. For every dollar of private shares purchased, an equivalent value of options was issued with 3-year terms. The first set of options expire next August, then some in September, and more in July 2017. We expect that by then, there will be some serious progress on revenue growth (the company makes a product) due to some major new distribution channels that are opening up. All told we’d have to pay nearly $70,000 to exercise all the warrants, but the latest funding round (which we did not participate in) was at a valuation 50% higher than the strike price. It is very possible that the value of the options will well-exceed the purchase price by the time they expire, which will make the choice pretty easy. If all goes well the company could have huge growth and would be a likely acquisition target at many times the current valuation.
I should clarify, I have stock warrants not options. I just looked up the distinction…it’s slim, but warrants are issued and fulfilled by the company (usually as a way to raise money) rather than by another investor.
I left a start-up after working there for 5 years. At the time of my leaving I knew the company needed to pivot and re-structure. My thinking was that I had already dedicated 5 years of my working life to the organization so I’d better make sure that I don’t miss out if things turned around. I spent $6,000 exercising options when I left. It’s been 3 years and the company is barely scraping by today. I’d be happy to get the money back but most likely it’ll be a major loss.
Good thing $6000 is not that much money. He would probably kick yourself if the company is doing well and the 6000 turned into 30,000.
Diversifying by individually picking stocks is still close to gambling at the end of the day, so I agree with you: if it’s not a huge amount of your total wealth, why not, as “play money”. But otherwise, no.
I’d say unless you really believe in the company’s future, then it’s not worth the risk. And then again, there’s a reason you’re leaving the company in the first place, right? If you thought they’d make it really big in the near future, wouldn’t you stay with them?
RSUs are a different matter, you have no choice but to take them. I blogged here on why RSUs need to be sold as soon as you get them:
That’s an interesting question. It really depends on how much I believe in the company and how much liquidity I have. But if she left the start up to go somewhere else, then it probably means she doesn’t believe in it anyway. It just depends. Personally, I’d lean toward not buying the options. I can see it from your perspective as a contractor, though.
Like most complex topics, buying your options depends on the situation.
In my one pre-IPO startup, it was a boutique startup, and knowing the founder and team, I knew it would never go anywhere significant (it hasn’t, the last 10 years), so I left the options behind.
Personally, I think it comes down to trust. How much do your trust your own ability to accurately evaluate the potential of your company when you leave? How much do you trust that company to treat private investors like you? Some companies operate honorably. Some companies are known to bend every rule to the breaking point to avoid giving anyone any money at all, ever. As an inconsequential investor in a private company, you have almost no insight into the company, and little practical recourse, should they decide to cheat you.
I would never invest any money in a pre-IPO startup I wasn’t prepared to lose 100%.
I agree. TRUST is tantamount. But hopefully, as an employee of the private company, you have great insight into the numbers. I didn’t see everything, but I saw enough to know that the direction was up and to the right.
I guess if the dollar amount was different than $9,000, say…. over $30,000… I would have a MUCH tougher decision to make regarding buying my options. At $50,000 or $100,000…. man, that is a lot of money to spend unless I know another round is coming at a higher valuation for sure. But even then, there’s no liquidity.
I’m slowly learning about the way stock options work at startups. I’ve never had the opportunity to get access to any type of RSUs or company stock before, so I find it o be quite an intriguing topic. Hypothetically speaking if I left a startup I might buy a portion of my options if I believed the company wasn’t going to fail. I might not want to risk buying all of them and losing that cash, but I also wouldn’t want to pass entirely and risk losing out on a nice gain later. I guess it would also largely depend on how much I’d have to pay in total. I might buy up to $15-20k, but anything over $20k would be pretty tough. Great insights, thanks!
Outside of being completely broke or seeing a clear and imminent demise of your (former) startup I think it’s always a good move to buy at least a portion of your options – especially if you were in before large up rounds.
You’ve already given years of your life to see this company succeed! Compared to that, the relatively small amount of money it will cost you to see what happens is worth the wild ride. Remember, strike prices on options are priced at a discount relative to the most recent valuation, so even if the exit is in line you still make SOMETHING.
That being said, thinking about how options work, what they could be worth, and how much it would “cost” you to leave and be forced to buy them are extremely important before you take an offer at a startup. Also important to consider what an ‘exit’ would even look like – acquisition? IPO? How many years? etc. Once you’ve taken the job and vested the shares, you’re already pot committed and might as well ride it out.
Hey Joe!
Good to see you here. Thanks for sharing your thoughts given your experience.
Good point about the strick prices on options being discounted to the recent valuation anyway, and there could be more discount for employees.
Exiting is the big X factor. Most can’t exit though, hence there has to be some type of discipline to deciding HOW MUCH to exercise. Perhaps don’t exercise all, but at least exercise some if you believe in the co.
Great post… with a lot to think about. And you’re right, if you really believe in the company, you’d be foolish to not buy the options. However, as Jim Wang in the comments (and you in the article) point out, your judgement of the company may be clouded by having worked there. In general, 99% (can’t remember the exact figure, but it’s a lot) of startups fail. So, if $10K-$100K is a big chunk of your net worth, then it may not be worth the risk.
Also, pre-IPO startups these days perform reverse-splits and a lot of other accounting techniques to get more value to the VCs and investment bankers and away from the common employee option holders, so you still may make a return, but 10-baggers are pretty rare anymore.
You hit on a really good point that established companies are more lucrative than startups. I’ve found that the very best time to join a company is about 8-18 months AFTER the IPO, if the company is still doing well after that. That’s after the executives, VCs, and bankers have taken their share of the valuation, and usually it’s when the stock price may be unusually suppressed due to the cashing out. At that point, the company is still giving out options to new hires, and you have a few years to decide how the company is doing before you have to make a decision on whether you want to exercise your options or not (and you usually can do a same-day sale because the company is public).
Interesting viewpoint on the best time to join a company is after the IPO. Hopefully the company is paying close to market salaries by then. But experience I had was that once my company when IPO, there was a lot of managers who started to slack off, and there was a lot of dissension among those who struck it rich and the relatively new were people who still had to put in their dues. When Goldman Sachs IPOed in 1999, so many of the managing directors left within several years and the firm grew it’s headcount by over 100% over the next three years.
I wouldn’t. There are too many variables and one’s opinion of the company is irrelevant and often based on inaccurate (or irrelevant) data. Plus once you leave, you have an even less useful view of the company. There are other private equity investment opportunities that won’t be clouded by personal bias… find one of those.
For me, it would be whether I believed in the future success of the company. The fact that I’d be leaving might actually give a pretty clear answer up front.
Not necessarily though. The bulk of most option grants are given in the beginning. After 3-4 years of vesting, you’ve basically got the majority of your grant. Hopefully management tops up those they want to keep. But for The most part, you get the most bang for your buck by working for 3 to 4 years and then leaving to get the next big option grant.
You always get the most money, both grants and salary, by moving. The anchor of your existing salary will drag you down… making that move, even if it’s laterally, will often come with a raise because they want you.