Founder - ESO Fund - Helping employees exercise stock options -- AMA

That's considered confidential but our data is being tracked by Cambridge Associates, the industry's top resource for this kind of data. We have raised 3 funds pretty quickly and will close another one pretty soon, so I guess we are doing okay.

Why is your fund’s performance confidential?

I think CrowdStrike was our highest ROI ever.

I’ve been in the VC industry for over 22 years and most of that time was spent doing traditional direct VC investments. In the document sets for an M&A and sometimes for major funding rounds, they include a Schedule of Exceptions which is a list of disclosures on risky matters. I noticed how incredibly thick it was and wondered how our great company could possibly be disclosing that much risk. Upon examination, I saw that it was mostly stock option grants that expired unused even though the company was clearly successful. That was my Eureka-moment. When I researched why these options were expiring, the answer was simply that people didn't have enough money for the exercise and taxes, nor the risk appetite or staying power to keep money tied up for a long time. Moreover, a dirty little secret at the board level was that typically only the executives were allowed to negotiate for NSO extensions or net-exercises to solve this problem without cash because of the high expense that the company would incur. So we founded ESO so that any one from the receptionist to the CEO could get the same benefit at better terms and without triggering expenses for the company.

👏🏼👏🏼👏🏼

So ISOs will convert to NSOs if you take one of these extensions. JUUL is going through some hard times so it makes a lot of sense to take a free extension. If your company is on fire, keeping your ISOs can result in a lot of tax savings. Then again, companies usually don't offer free extensions unless they need to calm down the masses.

@ESOfounder Once you've converted to NSOs, are there any tax mitigations to take advantage of?

First, you can go to www.esofund.com/equity to at least compare your percentile relative to others with similar backgrounds. One simple rule of thumb is to multiply # of shares * strike price and see if it is at least 1x your annual salary. If so, then you take a stab at how much your company can increase in value from where it is now. If it is an early stage company, it could be 10 to 100x more. If that happened, you'd be making 10 to 100 years worth of salary all at once.What some people do is search for opportunities to create a multiple equal to the number of years before their retirement. However, any company can grant a lot of shares so what matters the most is the quality of the company. I can help you look at that if you contact me off line.

How do you value RSUs?

If you are at a hot company that is very unlikely to fail then you want to start turning your ISOs into shares to qualify for long term capital gains tax. The cheapest way to do that is exercising just enough shares each year to stay below the zero AMT line. As of 2020, the AMT exemption threshold for Single tax filers is $72,900 and Married filers get $113,400. Going above the threshold a little bit can be worth it as well. It all boils down to how hot your company is and how fast the FMV is rising.

So does that mean if single, purchase up to $72,900 FMV worth of ISOs each year?

The pro would be reducing your future taxes and having your shares in pocket at a lower price in case a dream job comes along and you have to quit. The tax savings come in 3 forms: 1. early stage companies that are Qualified Small Business Stocks can get you up to $10 million in federal tax. 2. Anytime you hold exercised shares for at least 1 year, you'll get the lower long term capital gains tax rate. 3. Waiting to exercise after your FMV has risen could trigger a lot of AMT tax just to get the same number of shares. Cons: 1. You could lose your money 2. Your money will be tied up for awhile which means opportunity cost 3. If you pay AMT, you still have to pay capital gains tax on your final gain and try to reclaim your AMT via the credit process. You often don't get all of the AMT back. See this link for details: https://employeestockoptions.com/amt-credit-iso/ 4. Your company usually has a repurchase right on unvested shares. They can repurchase those at your exercise price without refunding any tax you've paid on those shares which means you'll have to take a loss on the sale and do the AMT credit thing.

You can read more on early exercising stock options here: https://www.esofund.com/blog/early-exercise-options-83b-election

If an employee is faced with having to exercise their stock options and pay the associated taxes, we can do that for them. That saves them money and eliminates the financial risk. It could take many years before an IPO or M&A exit event. If an employee needs some money in advance of that, we can provide it. This is true for both stock options and RSUs. We also structure deals to help maximize tax savings.

What's your cut?

It all depends on the quality of your company and how fast the FMV is rising. If the risk of failure is low and the risk of AMT from rising FMVs is high, then you should do the following: Exercise as many shares as you can afford each year without crossing into the AMT. You can find detailed instructions at this link on how to calculate that amount using Turbo Tax. https://employeestockoptions.com/amt-tax/ The timing of this exercise depends on if and when the FMV is rising. Most startups only adjust their FMVs once a year or when they close a new round of financing. As they approach an IPO or M&A event, they will adjust it more frequently. There should be chatter at the company water cooler about when this will happen so you want to exercise before they even start the appraisal process. Not before they announce it but before they start the appraisal since the effective date will be brought back to around the date the appraisal started. You'll want to exercise your entire year's budget at once. Although people do it for budget reasons, there is no tax benefit in dollar-cost-averaging your exercises monthly as you vest. Since the FMVs for hot companies rarely go down, you want to exercise all you can before the increase.

More on the optimal time to exercise stock options: https://www.esofund.com/blog/when-to-exercise-my-employee-stock-options

I think SaaS has been a perennial favorite, but I personally do not limit my team's activity to an investment theme such as gig-economy, crypto, etc. We'll look at anything that shows traction and some things that merely show promise. Zoom comes to mind but that was pretty recent. I'd have to think hard to find the best names over the last 22 years. SnapChat also comes to mind.