Startup Early Exercise / Net Exercise question

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Startup Early Exercise / Net Exercise question

Post by nacious » Thu Jun 30, 2016 11:03 pm

Hi, I have searched the web far and wide and without finding a good answer, have decided to ask for your help.

I am an early employee of a venture-backed startup (now Series A/B) who was given ISO stock options that have increased meaningfully in value. Let's use the following numbers for example:

- 35,000 vested options
- $1.00 exercise price
- $6.00 current fair market value

So in this example, the increase in value is $175,000.

The company has a chance to increase 10-fold...or to decrease to zero. Assuming I do not see it to the final outcome (by my choice or theirs, although there are no plans to leave), I am trying to decide how to act on the options without losing them, and to set myself up for long term capital gains (I did not file 83b), particularly since I am currently in a good position to negotiate equity arrangements with the company.

Since the risk profile is so high, what I would like to avoid is paying AMT out of pocket on the $175,000, which would be roughly $50k.

My ISO equity agreement has a "net-exercise" clause, written as follows:
by a “net exercise” arrangement pursuant to which the Company will
reduce the number of shares of Common Stock issued upon exercise by the largest whole
number of shares with a Fair Market Value that does not exceed the aggregate exercise price;
provided, however, that the Company shall accept a cash or other payment from the Participant
to the extent of any remaining balance of the aggregate exercise price not satisfied by such
reduction in the number of whole shares to be issued; provided, further, that shares of Common
Stock will no longer be outstanding under an Option and will not be exercisable thereafter to the
extent that (A) shares are used to pay the exercise price pursuant to the “net exercise,” (B) shares
are delivered to the Participant as a result of such exercise, and/or (C) shares are withheld to
satisfy tax withholding obligations
My main questions are:

A: Is the Fair Market Value calculation used to calculate the share reduction actually fair? Or, am I leaving value on the table and effectively diluting my shares vs. an acquisition or IPO outcome?

B: Would the taxes withheld be the AMT tax? Or would tax withholdings be at my income tax rate? (How could they even know my income tax rate?)

C: Would the net exercise look like this?
($5 share earned / $6 share price) = .83 * 35,000 = 29,166 options returned to me, then with x withheld for taxes.

D: Will these still be treated like an ISO option exercise such that I will not need to pay capital gains tax until the shares are sold?

E: Is there a better way?

Thank you!

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