Equity Guide for Employees at Fast-growing Companies

Conventional wisdom says that startup equity is worthless. And often, it is. But sometimes, it isn’t—sometimes, it’s life-changing. The difference lies in how you approach it.

Imagine you join a Series A startup as the 15th employee. The company is growing fast, customers love the product, and hiring is nonstop. You’re offered the chance to early exercise your stock options. The price? $40,000.

That feels like a lot. And it is. So you wait. Two years later, the company is valued at $1 billion. The cost to exercise? $400,000, thanks to taxes and a rising 409A valuation.

The difference? You just lost an opportunity to turn thousands into millions—all because of timing. Silicon Valley is full of stories where startup employees miss out on material tax savings, on the order of hundreds of thousands, sometimes millions of dollars, because they ignored their equity compensation until it was too late. This guide helps you strategically maximize your upside as an early startup employee at a fast-growing company.

Exercising your stock options represents a high-risk, potentially high-reward investment in your company. At a high level, here are the pros and cons of making such an investment:

The case for exercising early

The lower the 409A valuation, the less tax you pay. With the 409A rising, you’re incentivized to exercise sooner rather than later. Your options do expire eventually, so you can’t put off exercising them indefinitely. When you exercise, this will kickstart the one year long-term capital gains clock. Exercising also gives you more control over your future and breaks your golden handcuffs. The term golden handcuffs refers to compensation incentives that discourage you from leaving your company. While your equity may pose a large reward, if you cannot afford to exercise it, you’re monetarily encouraged to stay at your company until at least the IPO. If your startup succeeds, early actions give you a higher upside.

The case for waiting to exercise

Most startups don’t make it, meaning you could lose everything you invested. Investing capital into stock directly tied to your single source of income greatly increases your overall concentration in a risky, illiquid asset. The dollars used to exercise could be invested into public markets or real estate that have higher probability returns. Exercising creates tax liabilities that might not be immediately obvious or manageable.

To answer the question of whether or not you should exercise, consider the following:

Your liquidity constraints will limit the number of options that you are able to exercise. Can you afford to do it? Do you have other savings or investments? How long can you wait for a potential payout? What percentage of your net worth would be tied up in this investment? To determine these constraints, audit your personal finances. Consider metrics such as your current liquidity, investable assets, near-term liabilities, and financial goals.

Cash flow timing plays an important role, as startups often take 5-10 years to exit (if ever). Investing in your startup, therefore, comes with a significant opportunity cost: you could deploy this same capital into other opportunities (e.g., public stocks or real estate) that could generate steady, dependable returns over the course of those 5-10 years. .

In deciding how much stock to purchase, you are essentially quantifying your level of optimism in your company. While you’re unlikely to have access to every line item on your company’s income statement, you likely have access to key figures (e.g., revenue trends) to inform your analysis. Ultimately, you need to form your personal investment thesis—How strongly do you believe in the company’s future? Are investors continuing to invest at higher valuations? Is leadership making sound decisions? What will prevent you from succeeding? What’s the best case scenario?

At the same time, keep in mind that even startups with the most seemingly promising trajectories can stumble. WeWork is an obvious example: in early 2019, it was valued at $47 billion and was filing for an IPO. By the end of the year, its valuation had dropped to $8 billion. Pebble went from a $740 million valuation in 2015 to $40 million by 2016. Juul went from $38 billion in 2018 to $12 billion in 2020. Employees who exercised their options at the higher valuations fell out of the money (and overpaid in taxes).

To quantify this decision, let’s explore another example.

• You have 100,000 options, with a strike price of $1
• The current 409A valuation is $1.20
• The 409A in 3 years will be $20
• In 5 years, your company will IPO, and each share will be worth $100

Here are the various strategies you can try:

1. Early exercise everything now
2. Exercise all options in 3 years
3. Wait until the IPO to exercise

The table below estimates the hypothetical costs of exercising now, in 3 years, and in 5 years.

Importantly, these projections assume a successful outcome for your company and don’t account for relevant factors such as dilution, timing, and liquidation preferences. Early exercising performs worse than doing nothing in the event your startup fails. Exercising your stock options is making an investment in your company. You are betting on its future performance, and if it fails, you will lose your principal investment.

Deciding when to exercise is also a matter of timing. How soon do you need liquidity? It’s often possible to sell some of your equity before your company goes public (or gets acquired).

From time to time, your company may hold what’s called a tender offer. In a tender offer, some cohort of shareholders are allowed to sell their shares for a set price per share. Most companies irregularly hold tender offers (once every couple of years) and generally restrict them to current employees who’ve reached some level of tenure. Deciding whether or not to opt in to the tender offer has trade-offs—every share you sell is potentially worth more (or less) in the future. If your company offers a tender offer, it may be the easiest path. If not, exploring secondary markets or financing solutions could help bridge the gap.

A number of secondary markets make it possible to sell shares to independent investors. There are also funds and brokerages designed to help you get financing to exercise your options. It’s not guaranteed that you’ll be able to participate in either of these vehicles; it depends on factors such as transfer restrictions, timing, and demand from investors.

Startup equity is a paradox: the earlier you act, the more risk you take–but also, the greater the potential reward. No matter what, early-stage startups are inherently risky. You could end up with a life-changing pot of money in five years, or your equity could be worthless.

Ignore your equity, and it might end up worthless. Manage it strategically, and it could be the biggest financial opportunity of your life.

The best plan? One that balances risk, reward, and timing - and that starts with understanding your unique situation.

Consult your financial and tax professionals before making any major decisions.