Option Exercise Financing

If you have stock options, you need to decide if and when you exercise those options. Exercising stock options costs money and may come with a tax at exercise even if you intend to hold your shares. There is no clear answer when to exercise your options. It depends on your personal financial situation, your potential tax obligations, and whether your company allows early exercising. This article covers the ways in which you can finance both the cost of exercising options and the potential tax costs which may come about from exercising.

What is Option Exercise Financing?
Early Exercise Financing

What is Option Exercise Financing?

Several companies have come into existence in recent years that provide financial assistance for those who wish to exercise their options but may not have the capital to do so. Reach out to us if you would like our recommendation. There are three types of financing solutions we have seen in the market:

  1. Financing for the exercise of vested options – This solution will help you cover the cost associated with exercising stock options and the potential tax obligations
  2. Financing for early exercising stock options – Read more on early exercising in the section below. Financing solutions can also cover the costs associated with early exercising unvested options
  3. Financing for those who already own shares – There may be circumstances where you are illiquid. For example, you could have shares in a private company, which are valuable on paper, but you can’t sell them. There are solutions that will give you loans based on the implied value of your shares. This type of financing exists not only for stock options but also for RSUs and restricted stock

If you are looking for financing, there are a few things to be aware of:

  • First, pay attention to the terms of any option exercise financing agreement. You want to make sure that any loan is non-recourse, so lenders cannot come after your other assets in the event your shares fall in value. There are certain situations where individuals have taken out financing to exercise their options only to have their stock price fall in value and a lender require payment not only on the initial loan but also on the accrued interest. If your arrangement is non-recourse, the lender takes shares as collateral and cannot come after your other assets.
  • Additionally, know who has control over when to sell. Two years after financing your option exercise, you may believe that your stock will appreciate going forward, but your lender may want you to sell now. This potential disagreement should be clarified before any documents are signed.

Finally, you should consider how the other party is going to make money in this transaction. Do they need your share price to go up in value? What could go wrong, and how could they come after you in that scenario?

Early Exercise Financing

If you have the opportunity, you may want to exercise your options early. Read more about the benefits of early exercising here. If your company allows it, you can choose to exercise a portion or all of your options early. You can also choose to wait until there is an exit such as an IPO or sale to exercise your options. When you exercise during a liquidity event, you can sell a portion of your shares immediately in a same-day exercise, or cashless exercise, to cover both the cost of exercising and the cost of taxes.

Remember that the clock for long-term capital gains starts when you receive your shares. You need to have shares in hand to start qualifying for this lower tax rate, or in some cases, qualifying for Qualified Small Business Stock (QSBS) tax treatment. You can read more about QSBS here.

All content herein does not constitute legal, tax, or investment advice for any purpose. Topics discussed or referred to on StockBasedComp are based on authorities which are subject to change. It is recommended you speak with a qualified professional to advise on your personal situation.