How does an Air-Thru stock work?

How does the stock options for early employees in a startup work?

• I have joined a startup with 2 cofounders 10 months ago as first employee and i was offered 3% of the stock options. Seed round of funding was closed  a month after i joined the company. Now , i was planning to  exercise the options that are going to vest in couple of months but i was shocked looking at the amount i have to pay to buy the stocks and the tax implications for the stocks. The strike price is 8 cents per share and the current value is 43 cents per share. If i exercise the vested stock , i have to pay approximately 12k to buy the stock and  20k approximately for tax and next year if the valuation goes to $2 , i have to pay tax for a gain of1.92 cents  per share. I have read about section 83(b) but my CEO thinks it is not relevant . Is this how  stock options work for startups? if so, how are any employee leaving the startups before an liquidation event happens ? Are the strike prices so high even for early employees?

• Answer:

  Yes, that's pretty much how things work. Don't feel too bad, as it's still not uncommon for people to not fully understand all these details as they get involved in startups. The standard story they are used to hearing is always about a startup hitting it big, and everyone getting rich, but of course that's not how it often happens - that's why one should never join the startup thinking about the riches the options will bring. It can be a nice icing on the cake, or even a life-changing event one if things truly do go well, but in the end you better like your team, your mission, and your work enough to stick around for the long haul. Back to the question - if you can't afford to put up the cash to exercise the options and take care of the tax implications, and your startup isn't hitting serious traction yet, your options are limited. The two main ones are to cut your losses and leave the options on the table if you don't like the company or don't think it will do well, or (hopefully!) buckle down and grind it out until a liquidity event happens because you're doing something awesome, learning a lot, and having fun. Finally, let me give a brief overview of some other scenarios that I can think of that are relevant, but only apply in specific circumstances. If a startup is really hot and there is a secondary market for the shares, then an employee may be able to exercise and then sell a chunk of their shares to cover the costs of exercise and the tax bill (pretty much the same as Exercise-and-Sell-to-Cover or Exercise-and-Sell for options on publicly traded stocks). The company may make a loan to the employee to cover the costs - usually reserved for high-level executives and/or others who have leverage to negotiate such a deal. An organization / fund / individual may be able to loan the employee the money to cover the costs, in return for future interest in the stock (for an example of such a fund take a look at http://137ventures.com/) The company may decide to offer an "early exercise" provision in its Stock Option Agreement, and then have the Board approve certain grants as "early exercisable", in which case an employee with such a grant has an option (eek) to exercise their options before they are vested, receiving Restricted Stock (usually with same vesting schedule as the exercised option) rather than Common Stock in return. This is the scenario where an 83(b) election for the restricted stock may be extremely important for tax reasons (but it will do nothing to change your exercise cost). The early exercise option, however, is an additional hassle for the company to set up and administer, and even if it's available, the company has discretion in who it will grant it to. In any case, all this has to be figured out before the option agreement is signed. An early employee may be able to negotiate a grant of Restricted Stock rather than Stock Options. Since there are tax implications, it's easiest to do this while the company stock has only nominal value. It's possible to do later as well, but the additional cost and hassle must be worth it to the company. This is another scenario where an 83(b) election is essential. Hope this helps, and good luck. Here's one useful link, and Google will give you plenty more: http://gigaom.com/2011/06/05/5-mistakes-you-cant-afford-to-make-with-stock-options/