Stock options - is it worth the risks?

Question

I'm fairly new to the stock options based equity system and I'm not quite sure whether I understand its 'advantages' correctly.

I've been offered 7500 shares to a strike price of 1.7 € each.

So this means I need to put in 12k€ of my own net money to buy these shares. But then it's completely unclear when (if ever) I can sell these shares again?

* If the company never goes public that money is just locked away from me?

* If the company shuts down, the money is lost

* If the company goes public chances are still that it's evaluated lower than the original strike price

I won't even start with tax implications as I'm living in Germany and I'm fairly sure that 90% of accountants here wouldn't know how the (potential) gains are handled.

On top of that, in Germany, even if you make say 10k/month, your net salary is just a little more than 5k (yes, we give away roughly 50% for taxes and social/health insurance).

So investing 12k into such a gamble sounds unreasonable risky to me.

Am I missing anything? How does this all work out in the US? I have the impression that stock options are fairly popular over there.

MLE3760 · Accepted Answer

Options kinda imply it's a startup (or at least a private company). The number of shares and the strike price tell us almost nothing without the fair market value of a share (or equivalent, the company valuation).

But yeah, your worries are correct. There's a very low chance your options will ever be worth ANYTHING. There's an ever lower chance they will be worth a substantial amount. Unless the company is already super developed and close to IPO or acquisition, you should probably treat them like monopoly money.

Now for the technicalities of the options, you can cash them in during so-called "liquidity events" that include an IPO, acquisition or (rare but getting more popular) tender offers. These events are usually rare and long in the future, but it doesn't hurt to ask your hiring manager about the excepted timeline for these events.

The tax obligations vary a lot by country. I would recommend you check on r/Finanzen or even with an actual accountant - I strongly disagree that most would not know how these taxes are handled! But the specific tax system will also decide if it makes sense to hold on until close to a liquidity event and exercise them only then (when it's pretty certain you'll make a profit), or exercise them immediately after receiving them (when you're likely just throwing cash away).

In general, you should comprehensively assess the probability your company does well. Do you really believe in it religiously? Are you prepared to put in the hours to make it work? Or is it just another employer for you, and you don't particularly see them succeeding in the future? Remember that in a startup, you're likely pouring an awful lot of overtime in anyway, which is also equivalent to cash. It might even be worth more than those 12k to exercise...

ramenenjoyer · Answer

In the US, stock options are super popular in tech, but employees often exercise them closer to liquidity events (like IPO or acquisition). You can also sell the shares on secondary markets in some cases.

Tax implications vary, but the general vibe is that people treat it like a high-risk, high-reward part of the compensation package. In Germany, yeah... tax can get brutal, and accountants might not always be familiar with startup stock options.

Some thoughts to consider:

- You don't have to exercise right away. This might vary from company to company, but in my experience you can sit on the options until closer to the expiration date (usually a few years). This way, you can minimize upfront risk. 
- Partial exercise. You can buy a smaller portion instead of the full 12k to hedge your risk a bit.
- Do you really trust in your company? If so, then this decision would be a bet that you're taking because  you believe in the future rather than just because it could make you some more money.

Finally, if you're not comfortable with the risk and it's going to strain your finances, it's okay to pass. Stock options aren't guaranteed money - they're a bet. In the US, it's more normalized to take that gamble, but even then it's not like everyone does.

Good luck with your decision!

eightysixer · Answer

Your analysis is mostly correct. Stock options are "popular" here only because we have lots of startups. If you receive actual shares (RSUs), you are taxed immediately upon receipt, but if the shares are private/illiquid then the tax can be prohibitive.

When/how do your shares vest? In the US it's typically across four years. So really that 12k is more like 3k per year, it might be more reasonable. And of course you don't have to exercise all, or even any of the shares - that is the benefit of optionality. The options will still be valuable if there is a positive exit/liquidity event.

In the US, the tax treatment is generally better the sooner you exercise. If the strike price equals fair market value (FMV) then the tax cost to exercise is 0. Once fair market value greatly exceeds the strike price, the tax cost makes it prohibitive to exercise and you lose the optionality. This is the golden handcuffs scenario: you have paper wealth, but it is illiquid, and you lose it all if you leave your job.

Finally it's worth remembering there is little in the way of social safety nets here. So even a 2% chance to make millions is attractive when the worst case alternative is relative destitution.

My advice to you is to understand the German tax implications for your scenario, and also understand what happens to the options if you leave the company. But you can always choose to not exercise and hold on to the shares until the company goes public, and then it will be very obvious whether they are actually worth anything.

I look at options like a lottery ticket, with a much better chance of winning than the actual lottery, and I have some influence over the chances that it wins.

Stock options - is it worth the risks?

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