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Sec Rule 144 And Employee Stock Options

the holding requirement represents a period of illiquidity that can pose a significant financial burden to some employeesSEC Rule 144 governs the sale of restricted and control securities (here's a hyperlink to the SEC document). If you work for a venture-backed startup company that has not yet gone public, you will be purchasing restricted stock when you exercise your stock options. If you are a founder, executive, or a board director, then your stock may be subject to additional restrictions as a control security. If you wish to sell your stock prior to the issuing company going public and the expiration of the restrictions, then you will need to comply with the exemptions provided by Rule 144. The most significant requirement is the one year holding period. There is also a shorter six month holding requirement if the company is already public. After the holding period requirement is satisfied, holders of control securities who wish to sell more than 5000 shares or $50,000 in value within a 3-month period must also file Form 144 with the SEC to announce their intentions. Coincidentally, the one year holding requirement has the benefit of entitling the stockholder to receive long term capital gains treatment on possible gains from the stock.


The Rule 144 holding clock starts on the day your stock options are exercised. The main implication is that the holding requirement represents a period of illiquidity that can pose a significant financial burden to some employees. A low risk solution is to get funding from the ESO Fund to cover the cost of exercising the options as well as any associated taxes. An ESO loan will minimize the amount of valuable personal capital that is tied up in restricted stock. Pursuing a loan transaction with the ESO Fund will not negatively impact the timing of your Rule 144 holding period requirements. If you already own restricted stock from a prior exercise but need liquidity during the Rule 144 holding period, then the ESO Fund can also provide financing under similar terms that will not impact your Rule 144 holding period.

Exercising stock options is risky for many employees. It can require a lot of capital to be tied up for long periods of time and be subject to the possibility of total loss. ESO transactions are attractive because they are tax-efficient and have no payments until a liquidity event is reached on the stock. And if the stock becomes worthless, ESO bears the risk of loss. For more information, please contact us at the ESO Fund.

How To Create Incentives For Early Startup Employees Through Official Liquidity Programs

An ESO transaction can provide employees with discretionary cashVenture-backed startups rely heavily on employee stock options to attract and retain top talent. Stock options give the employees a piece of the company's upside, letting them benefit with the company's success. However, the current environment for IPOs often makes for a very long time horizon to achieve liquidity and has given rise to secondary markets for private company stock. Rather than having your employees distracted by searching for buyers of their shares and sharing confidential information with strangers, private companies should consider a private liquidity program.

In a company sponsored liquidity program, the company allows a third-party such as the Employee Stock Option Fund to provide cash liquidity to their employees. This means that confidential company due diligence is provided to only a single external entity under NDA rather than risking the outcome from numerous employees individually pursuing their own deals. The use of an ESO advance provides liquidity to employees on a low risk and tax efficient basis while not introducing any outside shareholders to the company's capitalization table. Unlike secondary market stock sales where strangers and possibly competitors get access to control and information rights, a liquidity program through ESO does not extend any management or information privileges to the ESO Fund. An ESO transaction can provide employees with discretionary cash while simultaneously preserving the employee's upside potential and thereby maintaining their loyalty to the company's ultimate success.

In addition to liquidity advances involving shares owned by employees, ESO can advance the funds to cover exercise costs. Employees benefit in numerous ways from exercising such as starting the clock on long term capital gains and avoiding heavy AMT tax consequences that can occur later if the company's stock rises in value. However, the cost of exercising can be beyond the reach of many employees. Moreover, the AMT tax triggered by the company's IRS Form 3921 filing can dramatically increase the cost of exercising. Companies therefore face a conundrum. On the one hand, they want to incentivize the employee by granting them options. But on the other hand, circumstances that prevent the employee from exercising can cripple these incentives. Owning common shares in the company gives existing employees a current stake in the business which can be a significant motivating factor.

The Employee Stock Option Fund provides financing for option exercise and for liquidity based on issued shares. No payments are due unless and until there is a liquidity event involving the company that issued the shares, such as a sale or IPO. At that time, the owner of the stock and ESO share the upside of the liquidity event and ESO is repaid. Please contact us if you'd like to learn more.

Monetizing Your Private Stock

the seller receives the purchase price so there is no opportunity for continuing gainStock in venture backed private companies is generally illiquid. In other words, there is a limited market for the stock since it is not freely transferable or publicly traded. Owners of common stock in private companies such as founders, employees, consultants, and others who wanted to obtain cash for their stock have traditionally either had to wait for a company liquidity event (for example, a sale or IPO of the company) or sell the shares on the secondary market. The problem with waiting for a liquidity event is that for many private companies, there will never be a liquidity event because the company will fail. And with a direct secondary sale of common stock, most buyers are interested only in large blocks of stock in "almost public companies" and when the stock is sold, the seller receives the purchase price so there is no opportunity for continuing gain.

The Employee Stock Option Fund can significantly mitigate these risks by providing financing against the value of the stock. No payments are due unless and until there is a liquidity event involving the company that issued the shares, such as a sale or IPO. At that time, the owner of the stock and ESO share the upside of the liquidity event and ESO is repaid. An advance from ESO to provide liquidity on your existing stock allows owners of common stock in private companies to obtain immediate funds while retaining significant upside with minimal risk.

If you'd like to know more about how ESO can help you monetize your private company stock, please contact us at the ESO Fund.

 

The 83b Election Helps You Exercise Options Well In Advance

Unvested assets don't have to be recognized as income as a safety measure for you. Venture-backed startup companies are big fans of using stock options as a major compensation tool to attract and retain employees. If your company's stock value rises over the years, you can avoid two major tax issues by having exercised early. However, since you haven't actually vested your stock and assuming your company even has an early exercise option, you would technically be holding restricted stock that is subject to repurchase by the company.

The IRS allows that unvested assets don't have to be recognized as income as a safety measure for you. This protective measure works against if you want to recognize the taxability of your asset earlier for the purposes of long term capital gains. To avoid your investment being characterized as exercises at your subsequent vesting points instead of the day you actually exercised, you need to make an 83(b) filing with the IRS within 30 days of your early exercise date to establish your actual purchase date.

By doing so, you are also agreeing to recognize the taxable value of your asset (if any) for the current tax year. If you don't, then your exercise will become taxable at the subsequent vesting dates when the Fair Market Value (FMV) is likely to be higher which results in more taxes. Filing an 83(b) with the IRS means that you are bound to consummate your intended stock purchase. The IRS isn't capable of tracking whether you actually carry that out so they simply subject you to the applicable taxation up front based on your expressed intent. However, your cost basis and the fair market value are equal up front so there shouldn't be any taxes due. The exception is if you waited some period of time before executing the early exercise and the fair market value of your company's stock at the time of exercise had risen above your option grant exercise price. Even then, you may or may not be subject to tax depending on several factors such as whether these were qualified ISOs, the implied gain in value, and your level of income.

Establishing the purchase date right away also makes the stock eligible for long term capital gains (LTCG) treatment after it is held for at least one year and at least two years have elapsed since the grant date. There is up to a 20% federal tax savings associated with LTCG for people in some tax brackets as of 2017 and this savings is always at risk every time new politicians are elected. Although there is no additional tax savings for California because capital gains and ordinary income are taxed at the same rate, there are many other states that do provide an additional tax savings for LTCG.

It is common for founders and early employees to get stock grants that are subject to repurchase by the company if they don't stay around long enough to vest. For these people, it is usually favorable to make an 83(b) election and pay the relatively small amount of taxes that would be due while the stock still has a low FMV. For example, a founder could get a grant of 1 million shares at a PAR Value of $0.001 per share which means they will elect to recognize $1,000 of ordinary income associated with the grant during the initial tax year. If founder's purchase their shares at par, then they invest $1000 instead of being taxed on $1000 in value.  An 83(b) election is required in either case. The savings from long term capital gains can be extraordinary down the road when these same shares are sold for a high value. Moreover, Qualified Small Business Stock tax exemption of up to $10 million applies in most founder situations. If the founder's stock grant isn't subject to re-purchase then the 83(b) isn't necessary but it is common for venture capital investors to request a vesting period as a condition of investment.

There is no special form for filing an 83(b) but you can download a sample from us. You are cautioned to review this with your tax advisor for compliance with your particular situation and since IRS rules are continually subject to change. Send 2 copies to the IRS along with a self-addressed stamped envelope for them to return a stamped acknowledgment. Also file one with your actual tax return in addition to keeping one copy for your records. Although this subsequent filing requirement went away in recent years to encourage e-filing, please check with your tax professional before skipping the filing. Exercising stock options early or voluntarily paying taxes on a large block of RSUs can require a lot of capital and yet the time to liquidity for your company can be quite long. Follow this link for a summary of other ways to reduce your stock option taxes.

As your shares are vested, you may be tempted to sell some shares to recover your original investment or perhaps fund other financial needs. Be aware that a sale is a taxable event and it also truncates any possibility of future upside on the shares being sold. An alternative solution for partial liquidity is to get an advance from the ESO Fund. This is an attractive solution because no payments are due until a liquidity event is reached on the stock. Furthermore, if the stock becomes worthless, ESO absorbs the loss, not you.

For more information, please contact us at the ESO Fund.