20 August 2023

Meet Taylor, the Amalgamated All-Stage Startup Person

By Adrian Colarusso, CFA, CFP®

August 20, 2023

Part two of Adrian’s case study on stock compensation:


In part one, you met one of our favorite* clients “Austin”, the RSU-earnin’ exec at a public tech company.

This time we’ll discuss the more potent form of stock compensation – options from startups.

The startup lifecycle is longer than I’ve been a practicing independent wealth advisor.

I can, however, stitch together a more complete case study from my experience with multiple clients in the startup world, from seed-stage, to gone-sideways (or gone-under), to post-IPO.

The tax and risk implications of options are way more nuanced than those of RSUs. We encourage the options-compensated among you to engage with us earlier than you think is necessary, as there are several factors you might be able to influence now that could make a big difference later.

“Taylor” is our composite startup client who uses they/them pronouns. (Thanks for the artistic license here.)

Let’s follow Taylor’s multi-dimensional journey through startup space-time from when they first took the job until they arrive in the universe where their company IPOs.

*You’re all one of our favorite clients

Taylor boards a rocket ship

“This thing is going to the moon!🚀🚀🚀” Taylor promised me when they took the Chief Growth Officer role at Company X. Here are a few aspects of the new job offer we helped Taylor contemplate:

  • Put on your investor hat. Although career satisfaction was Taylor’s primary motivation to take a new role, we worked with them to formulate the investment case. This is hard, even for professional investors. Do your best.
  • What counterbalances the risk? We worked with Taylor to determine which risk counterbalance they most identify with in this universe: 1) Their spouse’s job can cover the bills if the worst happens 2) There is stored wealth to backstop them 3) Their lifestyle is lean.
  • What are you leaving behind? Taylor had unvested RSUs from their previous company with a clearly defined market value. Discount for risk when translating that into the value of the startup options.
  • Does your options agreement include early-exercise provision, or an extended exercise window?
  • In one universe, Taylor is so confident in Company X, and they have enough cash to risk exercising their options right away – even before they vest (an “83b election”). This might substantially lower their tax bill if the rocket ship successfully takes off.
  • In another universe, Taylor will leave the start-up before a liquidity event and will be forced to exercise vested options within 90 days or lose them. If they negotiate an extended post-termination exercise window, they’ll be able to kick the risk can down the road until a liquidity event is nearer on the horizon.

The Valley of Despair

In 2022, the startup world faced turmoil when the Fed yanked the free-money punch bowl away from the party. Suddenly, founders needed more than a charismatic pulse to get funded, and strategies shifted from “distant-future-growth-at-all-costs” to “profitability, ASAP”.

After an initial period of optimism, Taylor lamented on one of our calls “I’m now totally getting what people mean when they talk about ‘the valley of despair’”. Although there might be tax advantages to exercising early when the spread is very narrow, that’s when risk is high.

Macro environment aside, startups always face existential risk during their growth trajectory. That’s why options-based compensation has such potent risk and reward characteristics. It cost a pre-revenue company almost nothing to give Taylor the right to buy some stock at a future date. And Taylor faced no downside (beyond the opportunity cost of their time) until exercise.

So, we decided it was best not to risk lighting money on fire by exercising too soon, just to potentially save some money on taxes.

Taylor still had faith and enthusiasm for Company X’s work to solve one of the world’s biggest problems, so they wanted to stay in their job and see it through.

We continued to monitor the company’s strategic progress, 409(a) valuation, the number of vested options, and Taylor’s holistic wealth picture to decide when to start exercising.

Getting close to the promised land

Taylor proved to be extremely effective in their role as Chief Growth Officer, and Company X made some serious headway.

In fact, Taylor had a performance review with their CEO coming up and wanted to ask for more equity before the valuation really took off.

I assigned some homework: “make a list of all of the customer accounts you helped bring on during your tenure, the annual recurring revenue for each, the percentage you feel you personally contributed to their acquisition, and a multiple of ARR at which the company or similar companies are currently valued.”

This analysis estimated the equity value that Taylor created for Company X, which made the requested top-up grant seem very reasonable in comparison.

New grant in hand, we started to exercise a portion of Taylor’s vested Incentive Stock Options (ISOs) while the spread was still reasonable. This started the clock on the one-year post-exercise holding period required for ISOs to retain their favorable tax treatment.

Working with Taylor’s CPA, we were careful to keep our total exercised spreads under the threshold that would trigger Alternative Minimum Tax, which, as a side benefit, drove discipline to avoid putting too much cash into illiquid, still risky shares.

Unloading the payload tax-efficiently

Company X went public in a spectacularly successful IPO! Hooray!

Taylor had a rats-nest of historical stock grants to sort through and turn into more diversified wealth. Quite a champagne problem.

An IPO opens new doors for managing taxes while reducing concentration risk.

Some shares we simply sold off and paid Taylor’s capital gains taxes, re-investing the proceeds into a direct indexing strategy. We harvested capital losses inside a diversified stock portfolio with overall gains, then applied those losses against gains in their company stock as we sold more.

Some shares got the “covered call” treatment, where Taylor took the other side of the stock options market and received income for selling call options on their stock. This effectively traded away further upside in Company X (I mean, enough is enough, right?) for immediate cash. We used that cash to pay taxes as we sold off more shares. We’d then add those proceeds to the direct indexing pot. The tax loss harvesting engine kept churning.

An unseasoned batch of ISOs needed to be “put on ice” until they reached the one-year hold milestone to receive favorable tax treatment. So for that, we turned to the options market again to swap risk exposure away from the individual stock and toward a diversified market index.

The most appreciated shares were placed into a Donor Advised Fund. The capital gains tax would be washed away as it became ear-marked for charitable giving, while giving Taylor an income tax write-off equal to the full market value of the shares contributed.

Where are they now?

With a comprehensive wealth plan in place, Taylor had the confidence to hang up the bootstraps for a bit and take a sabbatical. We keep a small portion of Company X in Taylor’s portfolio for sentimental reasons, and even ordered an authentic, old-fashioned stock certificate from the brokerage company to frame on the wall.

Taylor is now reverse engineering their next act, starting by defining “(Taylor’s Version)” of getting the ball in the hole from here. We at Target Rock Wealth Management are honored to help them manage the intersection between their wealth and their life’s purpose, hopefully for decades to come.