4 Ways to Pay for Your Stock Options Explained

Exercising your stock options means purchasing your company’s shares at a set price. This can be a significant opportunity, especially in SoCal, where many companies offer equity compensation. As the area boasts a high concentration of such companies, understanding stock options is crucial for local employees.

The ultimate goal of exercising your options is to become a shareholder and potentially sell those shares at a higher price as your company grows and becomes more valuable. However, not all employees are well-versed in how, when, or why to exercise their options. Many grapple with the challenge of funding this endeavor.

This is where professional financial planning in Los Angeles comes into play. If you’re working in the City of Angels, it’s highly beneficial to consult with an expert who can provide guidance on the ins and outs of exercising stock options. Before reaching out to a financial planner, it’s a good idea to equip yourself with knowledge on how to finance your stock options – and that’s precisely what we’re here to assist you with.

Is it a good idea to exercise stock options?

Whether or not to exercise your stock options depends on various factors, and it’s not a one-size-fits-all decision. It can be an attractive option if your company is demonstrating consistent growth in a stable or promising industry. However, the decision-making process can be complex, and taking action is easier said than done, especially when significant sums of money are involved. It’s crucial to thoroughly evaluate your unique situation from all angles before making a decision that suits your individual circumstances.

Why would you want to exercise stock options?

Speaking of decisions, not all employees end up purchasing their company’s shares, allowing us to assess the consequences of such actions. For example, employees have left $4.9 Billion on the table by not exercising their pre-IPO stock options in several renowned companies.

Employees left $4.9 Billion on the table by not exercising their pre-IPO stock options.

Top unexercised stock options:

1. Snowflake: $1,272,538,185
2. Airbnb: $966,683,219
3. DoorDash: $954,231,260
4. Unity Software: $321,753,834
5. Palantir: $250,600,109

From this perspective, not getting in touch with a financial planner and finding advice on ways to purchase your stock options very quickly becomes a missed opportunity.

Why do so many employees opt out of their stock options?

Here are the top reasons why so many employees opt out of their stock options:

• Poor Stock Performance: When company stocks aren’t performing well, employees might hesitate to invest, fearing a loss on their investment.
• Lack of Timely Information: Limited access to up-to-date information about the company’s financial health and stock performance can leave employees feeling uncertain about their investment decisions.
• High Costs: The expenses associated with exercising stock options, especially if it involves a substantial upfront cost, can deter employees from taking advantage of this benefit.
• Liquidity Concerns: Employees might worry about tying up a significant portion of their finances in company shares, potentially impacting their ability to access cash when needed.

Another significant reason is that paying for your stock options isn’t cheap. If you earn $125,000, how could you possibly afford to pay $100,000 to exercise them? Especially if you need to fork over another $12,500 to purchase your ESPPs and $6,200 (5%) of your salary to receive the 401k match. That’s nearly $119,000 for an employee who makes $125,000! To make matters worse, if you leave the company, your stock options expire within 90 days- putting more pressure on what was already a challenging situation.

Considering these challenges, consulting with a certified financial planner in Los Angeles can help navigate these complexities and make informed decisions about your stock options.

How do you pay for employee stock options?

Now, let’s address what is arguably the most critical aspect of employee stock options for the majority of individuals: how do you pay for them? There are several paths you can take to secure your company’s shares, and four worth considering are:

1. Consider using leverage
2. Approach friends and family
3. Personal loan
4. 3rd party equity financing
   

1. Consider using leverage

There is good debt and bad debt.

• Good debt: using debt to pay for an asset that is appreciating in value 
• Bad debt: using debt to finance big ticket personal assets such as cars or boats.

Bottom line – using debt may be a good idea if you structure it wisely.

• Margin Loan: A margin loan acts like a line of credit in which your assets in a non-qualified account (taxable brokerage), are used as collateral. There is no credit check, the interest rate is based on current Fed Funds rate + a percentage, which is negotiable depending on the size of your portfolio value. The terms are flexible, and there are no prepayment penalties.
  • For example, if you hold $200,000 in a taxable brokerage account, most brokerage firms will allow you to borrow up to 50% or $100,000. The interest rate of 3.5% (annualized) is applied to the outstanding balance and deducted monthly. Here’s the math: $100,000 @ 3.5% = $292 monthly.
• Home Equity Loan: A home equity line of credit (HELOC) is also an option if you own property. The approval process can be lengthy and is quite involved with employment history, running credit, and producing supporting documentation for a loan officer. Once approved, the line can be used “as needed” to pay for your company stock.

If you have a plan, then utilizing leverage via a margin loan or HELOC may put money in your pocket. How? By not leaving money on the table, not triggering tax on investments if you sell, and not disrupting your financial plan.

They give you options, and most importantly it gives you time to think about future decisions that may or may not be clear. If you’d like to get some more clarity, you can always turn to some of the best financial advisors in Los Angeles and allow them to help you with making your decision.

2. Approach friends and family

Turning to a friend or family member for money isn’t fun. It can be uncomfortable and downright embarrassing. The first step is to reset your priorities when considering this option.

• Priority #1: Change your mindset. This is an investment opportunity, not bailout money.
• Priority #2: You need a plan. Structure the deal as a way for your friends and family to participate in the performance of your company stock or structure it as a loan with a competitive interest rate.
• Priority #3: You need to execute, give them choices and flexible terms to invest. People love choices. Before asking, be prepared. Remember, you are negotiating the terms of an investment, so make sure it’s a clear call to action and answer the question – What’s in it for them?

Here is a helpful tidbit – throw assumptions out the window. Who you think are slam dunks, could turn you down. And who you assumed wouldn’t be interested or probably lacked the funds, could be willing and able. They are still friends and family, so be honest, clear, and forthright. Do not go into these conversations with any bias. Be transparent with the opportunity, but also with the risk. Clearly define who would assume the risk if the stock does NOT perform well.

To improve your chances, your pitch should include scenarios and flexible loan terms so it is viewed as an investment from the friend or family members point of view.

• Performance loan: Take the time yourself or find a resource that can help you model the details of your stock options with potential outcomes. For example, use excel or another calculator to show the friend or family member an initial investment, a range of possible returns with best-case versus worst-case scenarios, and repayment schedules. You can structure this deal as if they indirectly owned the shares of your company.
• Traditional loan: Draft an agreement and position the loan as a collateralized loan where you are essentially leveraging your exercised options as the asset. This is like using your home as collateral to take out a home equity line of credit (HELOC). The terms are more secure to the lender, meaning it gives them peace of mind knowing that you should be able to cover the outstanding balance from the asset itself. Set the borrowing terms and present a competitive interest rate that satisfies both your needs as the borrower and their needs as the lender. 

3. Personal loan

A “personal loan” is a loan you can get from an outfit like SOFI or Discover. It will carry a higher interest rate, but if your stock options are liquid, and you lack collateral (home or brokerage) to use as leverage, then it’s worth looking into. Several institutions provide these types of loans simply based on your credit score. Approval is quick, which makes them an appealing option if you need the cash. Minimum credit scores to qualify = 700+.

4. 3rd party equity financing

Another option is to obtain a cash advance from an “equity financing company” and use the money to pay for your options. The most common sources are Equity Bee and SecFi. In most cases you retain ownership or title to the stock and the “financing company” does not require any payments against the advanced loan that a traditional loan would require. 

Additionally, the financing company will often assume most of the risk associated with the purchase of the options as well – so if the stock doesn’t perform or never IPOs, the financing company takes the loss instead of the employee. Most importantly, employee stockholders retain the possibility of enjoying future appreciation in value. 

You can also advance funds for potential tax liabilities associated with the stock, such as Alternative Minimum Tax (AMT). By leveraging a “financing company,” you can diversify your risk by investing in other assets instead.

So, what is the downside here? Risk-free money to pay for my options AND taxes – this sounds too good to be true? And the answer is – it is a little too good to be true since there are some significant drawbacks to this option – Liquidity and Terms.

• Liquidity: Typically the “financing company” will dictate when and how much you can sell. They are representing their investors who funded the deal, and they need to make money. So, if your stock is doing well, there is a high likelihood they won’t allow you to sell. This has a tremendous impact on liquidity, which may or may not be in line with your goals. Purchasing a home or needing opportunity money would be on hold.
• Terms: Another drawback is the interest rate payments made on the advanced loan and the percentage cut the “financing company” will take on profits. There are two separate fees. The interest rate on the balance you borrowed to exercise (let’s call it 5%), and the cut or percentage they will take of profits (note: on a reduced scale), depending on how much your options are in the money.

Read the fine print and really, really, really understand the terms. The profit share percentage may be low, but there is limited risk for you as the equity holder, so it should still be considered. This is a profitable agreement for the financing companies when the stock performs well, (they wouldn’t enter an agreement unless they were optimistic) since they get a much larger percentage of the pie when all is said and done. That is why it is viewed as a last resort in most cases, and why the tone from equity financing companies is, “well it’s better than nothing, right?”

Hire an expert in financial planning in Los Angeles to exercise your stock options easily!

If you’re facing a decision about stock options or need guidance on financing company shares, you can rely on the expertise of Augusts Wealth, a reputable financial planning and management firm. With years of industry experience, our knowledgeable experts can help you become a knowledgeable shareholder in your Los Angeles-based company.

We’ll conduct a thorough assessment of your company and financial situation, providing tailored advice for your unique circumstances. Additionally, we offer insights on optimal timing for exercising employee stock options and what you should do if you own too much company stock. We’re also here to assist with understanding and implementing your 10b5-1 plans. Whatever your stock options’ financial aspects entail, simply give us a call, and we’ll address your specific needs.

Little Known Facts

• It costs on average nearly 2X annual household income to exercise stock options.
• Taxes made up 85% of stock option exercise cost