Funding Options for Exercising Options

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsel founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.

Quora is awesome. Today it provided me a real softball question for a blog post:

"How am I supposed to afford my stock options?"

Here's my answer:

When your options "vest," they "become exercisable." At that time you have the choice to exercise them or wait to exercise them later (or never).

When you decide to exercise, you may have more choices than simply paying cash. These will depend on the terms of your options (as described in your option agreement and the company's option plan), your company's policies, your ability to negotiate for favorable terms, and the existence of a public or private market for your company's stock. 

Here are the basics of each alternative:

1. Pay with a Promissory Note.

If the company allows you to pay the exercise price with a promissory note, you'll make an official promise to pay the company the exercise price and they will issue you the stock. This is not common, as it requires some thoughtful planning by the company to comply with the law. But I have seen it used for executives of private companies to exercise or even early exercise very valuable option grants.

2. Take Out a Loan.

If the company is promising enough to inspire you to exercise your options, it may also inspire a friend, a bank, or a special fund to loan you the money to make the exercise. The terms of such a loan would vary from a standard signature loan from a bank (much like borrowing on a credit card) to the non-recourse loans offered by specialized Silicon Valley funds. These special funds, such as The Employee Stock Option Fund (esofund.com), loan you the cash to exercise your options (and even to cover any tax liabilities at exercise). At a liquidity event, the funds are repaid and also participate in the upside of the stock. However, they do not require repayment if the stock later becomes valueless.

3. Cashless Exercise.

There are three steps in an exercise and sale -- pay cash for exercise, receive stock, sell stock. You may be able to cut out the "pay cash" portion by using a twist on the "Take Out a Loan" option above. Using a brokerage, you would borrow the money to exercise the options and immediately sell at least enough of the stock issued on exercise to repay the loan from the brokerage. This depends, of course, on having a buyer / market for the company stock.

4. Pay the Exercise Price in Stock.

If you already hold stock in the company, you may be able to use that stock to "pay" the exercise price. You would transfer your stock back to the company, and the current FMV of the transferred stock would be applied toward the exercise price of the options as if you were paying the exercise price in cash.

 

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsel founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.