Yes, plain and simple. You can exercise as many (or as few) option shares as you like once your options become exercisable. Sometimes options are “early exercisable,” which means you can purchase as many shares, vested or unvested, as you like after the date of grant. More commonly for employees, the shares are not early exercisable, meaning you have to wait until the shares vest to purchase them.
So, assuming your shares are either early exercisable or vested, the next question is, “Should I buy” and if, yes, “How many shares should I buy?”
Only you can answer these questions, but you’ll have to at least consider these factors:
Price & Cash Flow
The exercise price and your ability to access the needed cash to pay for the option shares will clearly impact if and how many shares you exercise.
If you are not able to afford the total number of shares you want to purchase, there may be some alternatives, such as net exercising, company loan or a third party lender.
Keep in mind that exercising your options might incur tax liability as well.
The type of option you are exercising may have certain tax implications that may impact your decision to exercise, largely for tax reasons. Companies usually issue two types of stock options: Incentive Stock Options and Nonqualified Stock Options (or “ISOs” and “NSOs”). There are two main differences between the two:
- Taxes on Exercise
When you exercise an NSO, you must pay taxes that year at ordinary income rates, on the difference between the fair market value of the stock on the date of exercise and the exercise price (aka the “spread”). All else equal, you want to exercise as many NSO options as you can as early as you can, in order to minimize the spread.
For example, if you exercise an NSO with an exercise price of $0.10 and the fair market value of the common stock on that date is $1.00, then the spread is $0.90 ($1.00 – $0.10) per share. If you wait five years until the stock has appreciated to $5.00 a share, the spread becomes $4.90. So if you exercise 100 shares for $10, you would owe ordinary income tax on either $90 or $490.
ISO shares do not result in any taxable income when exercised, unless you are subject to Alternative Minimum Tax (“AMT”).
- Long-Term Capital Gains
Capital gain, is any gain from the sale or exchange of a capital asset, such as Capital gain, is any gain from the sale or exchange of a capital asset, such as stock, bonds or real estate. Depending on how long the asset is held, it may be taxed at ordinary income rates or at lower “long-term capital gains” rates.
The stock underlying an ISO grant has to be held for 1 year from the date of exercise *and* 2 years from the date of the option grant, to be taxed at the lower long-term capital gains rate.
NSO stock only has to be held for 1 year from the date of exercise to be taxed as long-term capital gains.
The terms of your grant likely contain a few timing restrictions on when you can or must exercise. You’ll have to look at your own paperwork to see what limitations you may face, but the most common are the requirement that you must exercise:
- Within 10 years of the date of grant
- Within 3 months of leaving the company (if you have an ISO)
- Within 6 months of leaving the company due to death or disability
Appetite for risk
Lastly, but probably most importantly, is your appetite for risk. You’re already working for this startup, so you clearly believe in its mission. And you likely appreciate the risk associated with working for and investing in a startup. So now you have to hone those senses and assess whether you believe in the future trajectory of your company. So much so, that you’re willing to invest money by exercising your shares.
Valuing your equity is not an easy task, but it’s a worthwhile one as you consider whether or not to purchase your stock.
Nothing herein is intended as tax or legal advice and is for informational purposes only.