Ask HN: I am considering leaving my start-up. Should I exercise my options?

Tough call. Let me tell you two stories.

Story one: a friend of mine worked at a startup that lasted ~5 years. He left in year four and exercised his (substantial) options. The company was, as I understood it, pro-forma cash flow positive, in a bright industry. And indeed, just over a year later, they were acquired for many tens of millions of dollars.

Unfortunately, they weren't acquired for enough money to sufficiently offset VC liquidation preferences. To mitigate this problem, the company and its acquirer created an incentive pool to create a fairly decent "earnout-style" return for existing employees. Former employees holding common stock? Zilch.

Story two occurs right around the time I heard story one. A guy joins a startup, sticks around for just shy of four years, leaves with a nice chunk of unexercised options to start another company. "Buy private company common stock and wind up like person one? Never!" Besides, person two needed the money for the new company.

Fast forward five years, and company two is acquired at a... non-negligible... price per share. Person two is out a fairly big chunk of cash. Person two's old boss makes douchey comment on IM! Person two is sad.

Well, for a few seconds; then he's happy his friends did well. He also rationalizes:

* The investment at the time was anything but risk-free, even if the company was acquired.

* It's not like the money didn't get invested; it just got invested in a company that hasn't 10x'd the investment yet.

* The money that would have gone into exercising the options would have been locked up for five years.

Before I bought private company common stock, I'd want to know everything about:

* The number of outstanding shares and as much as possible about the terms the current investors have. What preferences do the VC's have? "We're shooting for 100MM" might be code for "We make fuck all unless we hit 100MM" --- and note that not many companies can pay 100MM for other companies.

* The likelihood of future investment rounds in the company, which will have deliterious effects on the value of your shares.

* How stable and reliable the management team is. Is the current CEO new? Is the company making its numbers?

If it's not "real money", and iff you can't put the same money to good use in your new venture, I'd go ahead and exercise.

The kicker here is usually the tax liability depending on your jurisdiction.

Would you be looking at a large tax bill in addition to the cost of the options? If you have to pay taxes based on the current valuation of the company even if you can't sell the shares then exercising becomes that much higher risk.

This.

The US tax laws in this respect are retarded; you have to pay taxes at the moment you exercise your options, regardless of whether you can resell them or not. In the previous bubble, it happened that people exercised options that made them tax liable for e.g. $1M (because e.g. an IPO made it worth $5M), but had a lockup of 6-months, which is quite common, and at the end of the lockup period, their stocks were worth less than $1M.

In some other countries, you only pay taxes when you actually see money. That makes a lot more sense.

And, Israel is now considering a new tax law which says an investment into a "startup" (whatever that means) is immediately considered a capital loss. Then, if it makes money, you have capital gain. for large-capital-base angels, it makes cash flow simpler, -- and in fact, if they elect to use it, they'll pay more taxes on their successes at the end. for small-time angels making one or two investments a year, it is a huge difference in cashflow. for the state, it doesn't matter in the long run, because it just gets the capital lost written down sooner than later.

Here's another way to think about it: if you had a pile of cash in the low five figures, would you re-invest it to speculate on that $100M acquisition? Or would you take it and pursue other opportunities?

If the tax implications are ok, can you borrow funds to cover the discounted stock purchase price, sell the stock, pay back the cost basis, keep the profits and don't look back?

It's a privately owned company. The stock is worthless. He can't buy it and then flip it on the open market because there is no market.

Could he could sell them to another shareholder?

As others are pointing out, options and stock in private companies are, as a rule, worthless. (Unless you're the majority shareholder, and often even then.)

The only protection you have against having your shares be made worthless is that the company wants your ongoing goodwill, because you're a current employee in an acquisition. If you're an ex-employee, you've got no leverage whatsoever.

Suppose you owned 90% of a private company, and an ex-employee who resigned a few years prior owned 10%. You have an acquisition offer. Would YOU structure the deal so that the ex-employee got his 10%? Or would you structure the deal so that he got nothing and you got it all? There's no legal penalty for following either option. I think most of you reading this would invent some sort of rationale for screwing the ex-employee (he didn't stick around when we needed him, he didn't pull his weight, he doesn't deserve this payoff that I worked so hard for...), and would then proceed to do so.

Unfortunately, they weren't acquired for enough money to sufficiently offset VC liquidation preferences. To mitigate this problem, the company and its acquirer created an incentive pool to create a fairly decent "earnout-style" return for existing employees. Former employees holding common stock? Zilch.

This happened to me at the first startup I worked at. I lost $18K, which was about half the money I had at the time.

I don't know what to tell you. My other companies had reverse vesting... but those ended up being worthless as well.

My new rule of thumb is to not spend more than 5% of my cash reserves on an options exercise. (I have a lot more cash now, so this could still be a significant exercise)

There's also a non-binary approach -- exercise some of your options (i.e. not 0%, not 100%). Figure out how much money (e.g. $100, $1000, $2500, $10000?) you're comfortable losing entirely should the stock become worthless, and what percentage of your vested options that allows you to exercise, and use that as a starting figure. Then adjust that based on how much more risk you are willing to take because you really think the company will succeed.

Has the company already received multiple serious acquisition offers and turned them down? Or at least some very serious interest from big companies? That's often the case with companies that end up selling for >$100M.

If that is the case then it's easy: do it. If they haven't then perhaps you should exercise half them as a hedge against kicking yourself later.

you should sell them.... to me