When Your Stock Options are Underwater
What to Do When Your Startup Stock Options Are Underwater
Understanding Underwater Stock Options
When you join a startup, equity compensation often forms a significant part of your total compensation package. This typically comes in the form of stock options—the right to purchase company shares at a predetermined price (the "strike price" or "exercise price") after a vesting period.
Stock options are considered "underwater" when the current fair market value (FMV) of the company's shares falls below your strike price. In simple terms: if you were to exercise your options today, you'd be paying more for the shares than they're actually worth on the market.
Example:
Your stock options have a strike price of $10 per share
The company's current FMV is $6 per share
Your options are underwater by $4 per share
How to Determine if Your Options Are Underwater
Identifying underwater options requires two key pieces of information:
Your Strike Price: This is documented in your option grant agreement, which you should have received when you joined the company.
Current Fair Market Value (FMV): This can be more challenging to determine for private companies. Sources include:
Recent 409A valuations (companies typically perform these annually)
Recent funding rounds
Secondary market transactions
Information provided during company-wide financial updates
For publicly traded companies, determining FMV is straightforward—it's the current market price of the shares.
Why Options Go Underwater
Several factors can cause stock options to become underwater:
Market Downturns: Overall economic conditions affecting company valuations
Industry-Specific Challenges: Regulatory changes, new competition, or technological shifts
Company Performance Issues: Missed targets, failed product launches, or leadership problems
Down Rounds: New funding at a lower valuation than previous rounds
Overvaluation in Previous Rounds: If your strike price was set during a period of inflated valuations
Strategic Considerations When Holding Underwater Options
1. Evaluate the Company's Trajectory
Before making any decisions, assess:
Business Fundamentals: Is the company's core business model sound?
Leadership Quality: Do you have confidence in the executive team?
Growth Path: Is there a clear, viable path to increased valuation?
Funding Status: Does the company have sufficient runway, or is it at risk of running out of cash?
Market Conditions: Are the company's struggles unique or part of a broader market correction?
2. Consider Your Vesting Schedule
Early in Vesting: If you're early in your vesting schedule, you have more time for a potential recovery
Near Completion: If you're close to being fully vested, the "golden handcuffs" effect is weaker
Cliff Period: If you haven't reached your cliff (typically one year), leaving means forfeiting all options
3. Assess the Gap Size
Slightly Underwater: Options just marginally underwater might recover more easily
Significantly Underwater: Large gaps may require dramatic company performance improvements or restructuring to recover
4. Calculate the Opportunity Cost
Alternative Compensation: Could you earn significantly more cash compensation elsewhere?
Other Equity Opportunities: Are there companies offering equity with better growth potential?
Career Development: Are you gaining valuable skills and experience that justify staying despite underwater options?
Possible Courses of Action
1. Stay the Course
When to consider this approach:
You believe strongly in the company's long-term vision
Recent setbacks appear temporary rather than structural
You value other aspects of the job (culture, work, learning opportunities)
You're relatively early in your vesting schedule
Potential benefits:
Avoiding the "buying high, selling low" mistake
Maintaining stability in your career
Potential for significant upside if the company rebounds
2. Request Option Repricing or Additional Grants
Companies facing widespread underwater options may consider:
Repricing: Adjusting the strike price of existing options to reflect current FMV
Option Exchange Programs: Trading underwater options for fewer options at a lower strike price
Supplemental Grants: Issuing additional options at the new, lower FMV
How to approach this conversation:
Research whether other employees face similar situations
Frame the discussion around retention and motivation
Understand that repricing has tax and accounting implications for the company
Time your request with annual compensation reviews when possible
3. Negotiate Compensation Adjustments
If repricing isn't feasible, consider:
Salary Increases: To offset the lost expected value from options
Performance Bonuses: Tied to company or individual milestones
Restricted Stock Units (RSUs): These have value regardless of price fluctuations
Additional Options: New grants at the current lower FMV
4. Plan Your Exit
If the outlook appears bleak, it may be time to look elsewhere:
Considerations before leaving:
Exercise Analysis: Determine if any vested options are worth exercising despite being underwater (rare, but possible for tax planning)
Notice Period: Plan your departure to maximize any upcoming vesting milestones
Employment Agreement Review: Check for any contractual obligations or restrictions
During your job search:
Be prepared to explain your equity situation to potential employers
Research equity structures at prospective companies to avoid similar pitfalls
Consider negotiating for more cash compensation if you're skeptical about equity
Legal and Financial Considerations
Exercise Windows
Most startups have a limited post-employment exercise window (often 90 days). If you leave:
Underwater options rarely make sense to exercise
However, review your specific grant terms, as some companies offer extended exercise windows
Tax Implications
NSOs (Non-qualified Stock Options): Little tax consequence for underwater options
ISOs (Incentive Stock Options): May have Alternative Minimum Tax (AMT) considerations even with underwater options
Tax Loss Harvesting: In rare cases where you've previously exercised options that are now worth less
Always consult a tax professional about your specific situation
Documentation Review
Before making any decisions, carefully review:
Your original option grant agreement
The company's equity incentive plan
Any communications about valuations or repricing programs
Making Your Decision: A Framework
Gather Information:
Current company valuation and trends
Vesting schedule and exercise terms
Market compensation for your role
Company's financial health and prospects
Calculate Scenarios:
Best case: Company rebounds significantly
Expected case: Moderate improvement or stability
Worst case: Further devaluation
Assess Personal Factors:
Financial needs and risk tolerance
Career development goals
Job satisfaction beyond compensation
Alternative opportunities
Create an Action Timeline:
Set checkpoints for reassessment
Identify triggers that would prompt action
Plan conversations with management
Red Flags vs. Temporary Setbacks
Concerning Signs:
Multiple down rounds
Executive departures
Significant layoffs without strategic explanation
Lack of transparency about company finances
Repeated missed targets
Dwindling market share
Potential Recovery Indicators:
Clear communication about challenges and solutions
New strategic direction with measurable milestones
Cost-cutting that preserves core capabilities
New leadership with relevant turnaround experience
Interest from new investors despite challenges
Final Thoughts
Underwater options represent a challenging situation, but not necessarily a hopeless one. The tech landscape is filled with companies that experienced significant valuation dips before achieving tremendous success.
The right decision varies based on your unique circumstances, risk tolerance, and career goals. By systematically evaluating your options (both literally and figuratively), you can make a choice that aligns with your long-term professional and financial objectives.
Remember that equity is just one component of compensation and career satisfaction. Consider the total picture—including work environment, growth opportunities, and alignment with your values—when deciding whether to stay or seek new opportunities.
Last updated