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So, if you have private stock, should you wait until the stock goes public and address the issues then? Or do you plan now, maybe exercise and hold some of your shares, and hope that you put yourself in a better position later? Whether your company is publicly traded or privately held, you should review your equity compensation package and fully understand the details before trying to make any plans or decisions. Knowing these specific details for your options may give you the information you need to make informed decisions about what to do with your equity compensation. Stock options at private companies are often issued with a low strike price.

This allows you a chance to buy shares for a low cost, which requires less cash up front. This is a good thing when you consider how your cash flow will be impacted by an exercise — but this is only one thing to consider. You should also evaluate the cash you may need to pay a potential tax liability if you exercise and hold your options. Exercising stock options is a reportable taxable event regardless of whether or not your company is private or public.

One benefit of a publicly-traded stock is that if you want to sell your shares, you can likely do so on a public exchange.

How to Price Your Stock Options (and Avoid IRS Noncompliance Penalties)

Some private companies will allow you to sell shares in a secondary market, which gives you a chance to sell shares you own after exercising. However, not all private companies offer this luxury. Even if your company allows for the sale of shares in a secondary market, they may have other restrictions in place that you must adhere to as well, such as a right of first refusal. If your company is private and has no secondary market where you can sell your shares, you should consider how this will impact your willingness to exercise your options.

When you exercise stock options, it is a taxable event. How you report the taxable event and how much tax you pay depends on several factors, like whether or not you have incentive stock options or non-qualified stock options. If we assume that you have incentive stock options , the tax rules state that if you exercise and hold the shares past calendar year-end, the bargain element is a reportable event for calculating the alternative minimum tax. Non-qualified stock options , on the other hand, may be taxed as ordinary income when you exercise. But no matter what kind of options you have, exercising them may cause you to pay taxes — regardless of whether the company is public or private.

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There can be considerable risk associated with exercising private company stock and the cash call necessary to exercise and hold shares. But while the risk is real, there may be some advantages to exercising your private company stock, too. One potential advantage of exercising private stock is that the AMT impact may be lower now than it may otherwise be in the future. A key factor in determining how much AMT you owe from an exercise of incentive stock options is the spread between the fair market value at exercise and the strike price.

How to value startup stock options when comparing job offers

If we assume that the spread between the two is smaller now than it will be later, the AMT you may need to pay will likely be smaller, too. The net result of this may mean that you can exercise and incentive stock options now with a lesser tax impact than you will have in the future. Exercising sooner rather than later may also be beneficial when you want to sell your shares.

You could not only secure a lower bargain element when you exercise and hold, but you also begin the holding period requirements for a qualifying disposition.

Why Not Stock or Options?

This means that you can sell your shares sooner rather than later assuming there is a market to sell and still obtain long term capital gains treatment. The multiple to affix depends on the growth rate of the company, its gross margin, its profit margin, and several other key factors.

Fortunately, there are a few ways to get a sense. Who has all the information we just talked about? The A valuation assessor. To create their assessment of the fair market value, an assessor will look at these factors and compare it to public companies with similar characteristics. Second, they will also do their best to compare it to relevant acquisitions done in the market. Finally, they will look at any recent funding rounds done by the company and what price was paid by the new investors. They arrive at a number. Your CEO might even just come out and share this information with employees at the next town hall.

These are real people putting their money where their mouth is. The most important difference in having preferred shares is what is called a liquidation preference. This is an extremely common characteristic of preferred shares, though it is not necessarily always there.

Common Stock Valuation and Option Pricing by Private Companies

It means they get their money back first before anything else happens with the other equity holders read: you. Your company was a tech darling and commanded a huge valuation. That has two implications for you, Mr. This is the most disappointing thing about options when it comes to employees. How are you to know how much liquidation preference there is in the company? This is all sensitive information kept behind privacy screens in the finance office.

I agree with you. So you want to feel truly in the money before locking up cash in these options and leaving them out there for who knows how many years. The best scenario is just to be employed at the time of a sale, in which case all this will be made transparent and money will arrive in your bank account without you having to pony up cash most times they will just calculate how much you would have made and send you the difference.

However, because of this lack of transparency, I place much less value in stock options unless the company is publicly traded. The exception is if you are C-level employee who has access to all this information. But as a developer or mid-level manager in a privately owned company? Make sure you see your way to Of course, this is just one point of view and I encourage you to consult a lawyer about the details.

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Other folks who work in the space, feel free to weigh in. Your email address will not be published. Notify me of follow-up comments by email. Notify me of new posts by email. Written by someone who retired at 28, The Money Habit is a personal finance site that focuses on investing, saving, and earning strategies to help you achieve financial security.