As reported by TechCrunch, Airbnb is on the verge of raising close to $1 billion with a valuation of $20 billion. To say the sharing economy has arrived would be a massive understatement. The smartest investors in the world are IN. It is also rumored that Fidelity is tossing its hat into the mix with Airbnb as part of the upcoming round. An increasing valuation is exciting. It means a lot of things, but it undoubtedly means that the Company is growing quickly and gaining traction every second. I think $20 billion tells the story.
For employees of Airbnb, the times are exciting, especially for those who own stock. The Company is hotter than ever, the share value of their equity is skyrocketing, and they get to tell friends and family they work at Airbnb, a Company that is literally changing the world. And in honor of the last episode of Parks & Recreation this past week – as Rob Lowe would say: literally.
The increased valuation that will be coming down the pipeline means that equity is more valuable, but it also means it will become far more expensive to exercise options. For the Airbnb employees who have incentive stock options (ISO’s), waiting on exercising any vested options until the new valuation hits may be a costly decision. The fact is, as the valuation increases, AMT exposure also increases and proper planning becomes more difficult. To illustrate, let’s use an example from SpaceX, another hot, yet still privately-held company.
John is an engineer and has worked at SpaceX since 2008. He’s been granted 60,000 options over the years and has a chunk of 15,000 options that have a $.95 cent strike price. The current valuation of SpaceX stock for 409(a) purposes is nearing $100 but we will just use a number of $80 for this example. If John proceeds to exercise all 15,000 options at $.95, he will cut a check for $14,250 to take ownership. The hidden cost that is often overlooked is the AMT consequence of this. Because the difference between FMV ($80) and the exercise price ($.95) is added back to income for AMT purposes, John could be looking at a tax bill for $332,010.
Here is how it works:
AMT add-back is $80 minus (-) $.95 = $79.05 per share
$79.05 per share multiplied (x) by 15,000 shares = $1,185,750
$1,185,750 multiplied (x) by AMT rate (28%) = $332,010.
As you can see – exercising can be a challenge even if this is all known and quantified before making the decision. To drive the point home, a lower valuation of $40 per share would reduce the AMT exposure to $164,010, while a higher valuation of $160 per share would more than double the AMT exposure to $668,010.
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Liquidity an Issue?
If cash flow is not a barrier, the general philosophy is “exercise early, exercise often”. Generally, exercising ISO’s as soon as they vest is a good move. The reason not to would be if you thought the Company was going in a negative direction and the value was going to decline.
If the reason you are not exercising is because you cannot afford to pay the AMT and/or the cost to exercise, there are other avenues for you to gain liquidity. It may require selling a small number of shares on the private market, but it allows you to exercise and hold your shares and capture the vast majority of the upside.