Stock options too expensive to exercise? You may be able to get financing

Working for a startup often means taking on a little bit more uncertainty in exchange for a potentially brighter future.

You might be putting in long hours to help grow a company that you think will be the next Amazon, Netflix, or Uber. And you might have accepted a slightly lower base salary than you could’ve received at a more established company.

The possible upside? Employee stock options.

Ideally, you can exercise your stock options and sell the resulting shares for a potential windfall if the value of the underlying shares has increased since your options were granted. The more the company (i.e., its share price) grows, theoretically the more you can earn.

Still, stock options carry risks, and they can be costly to exercise. You might not have the funds available to convert your options into actual shares, or you may choose not to self-fund the exercise cost.

The good news is that employees often have several ways to afford to exercise options. Stock option loans or other forms of financing can potentially help you afford to exercise your options. After that, you could look to sell them for cash, hopefully at a sizable profit.

How does exercising stock options work?

When you receive employee stock options, you gain the right to buy company stock at a given price, known as the exercise price or strike price. However, you won’t actually own the stock underlying the options unless you exercise this right. Generally, stock options also have a vesting schedule, where the longer you’re at the company, the larger the percentage of your granted stock options vest (i.e., can be exercised).

So, while you might have negotiated a compensation package that includes a large chunk of stock options, any value the options have might be locked up until you can exercise them and then sell the resulting stock.

To exercise stock options, you pay the exercise price for each option you’d like to convert into a share of stock.

Suppose you’ve vested 5,000 stock options with a $10 per share strike price. That means you’d have to come up with $50,000 to convert your stock options into actual shares. While you’d then have 5,000 shares of stock, even if the value of the shares is above $10 per share, you wouldn’t realize that potential gain unless and until you can sell your shares.

There’s also no guarantee that the shares will build or retain value, and the timeline for selling shares can be unpredictable. You might have to wait several years to be able to sell your shares on the open market, even if you have nearer-term cash needs.

What if I don’t have the funds to exercise stock options?

Perhaps you’re getting ready to leave your company but, knowing that options often expire within a set number of days after departure from a company, you may decide you do not want to leave vested stock options on the table without exercising during that window. Or maybe you just want to exercise now for tax purposes, or so you have the shares available when you're eventually ready to sell.

But what happens if you don’t have the funds to exercise stock options or don’t want to self-fund? The good news is that you may be able to get employee stock option financing to cover the strike price.

How does financing of stock option exercise work?

Stock option financing lenders can potentially make funds available for you to exercise your stock options.

For example, if you borrow $50,000 to exercise your stock options at a $10 strike price, and then the actual stock price goes up to $20 per share, you could then potentially sell your stock for $100,000. In addition to repaying the loan, there are typically taxes and fees associated with the loan or sale of shares. However, a sale could potentially yield a profit that might make employee stock option financing worth it.

The specifics of the repayment can differ depending on the stock option financing terms. Two common structures include:

• Equity repayment

  Some stock option financing providers offer paths to access funds to exercise your stock options in exchange for a percentage of your equity (i.e., the shares obtained by exercising your options) if your company has a liquidity event, such as an initial public offering (IPO). If that never occurs and your stock loses its value, you might not have to repay the loan, but that of course depends on the terms of the specific loan. (In many cases, these providers also charge fees in addition to the equity percentage.)

  While that might sound like a sweetheart deal, the devil is in the details. Some stock option lenders take 40% (or more) of your equity, so you could potentially be forfeiting gains in exchange for the downside protection of not having to self-fund.

• Flat fee

  Another stock option financing route is to take a loan against your pre-IPO shares for a flat fee. A Forge Options Exercise Bridge Loan, for example, provides financing for private share option exercises if you’re willing to sell the resulting shares upon exercise.

  As part of the process, Forge Lending works with you for a flat rate to provide you a loan to fund your options exercise, where the resulting shares serve as collateral for the loan. Interest and additional fees may apply in certain circumstances, which would be discussed and confirmed before a loan is provided. Separately, Forge Markets charges a commission when you sell the shares.

  With this type of loan, you can exercise your stock options and potentially sell right after that exercise, without taking on the valuation and liquidity risks that can come from holding onto your shares.

  Another possibility is to take out other types of loans, like a personal loan or a home equity loan, that you can use to finance your stock option exercise. However, these types of loans can carry additional risks and costs. For example, if you can’t pay back your home equity loan due to your company shares losing value, your home could be at risk of foreclosure.

Overall, stock option financing can be helpful to employees who don’t have the cash available to exercise but who want to participate in the potential upside of owning and selling company shares.

Taking a loan against pre-IPO stock can carry risks, however, which can vary depending on the type of financing you obtain. So, if you are considering stock option financing, compare your financing choices closely, consider speaking to your tax, investment and/or legal advisors, and consider all factors in trying to accomplish your particular goals, be they to profit from your stock options, protect yourself from losses, other considerations or a combination of some or all of the above.