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Saturday, April 10, 2010

AMT and stock options

An e-mail came into my mail box addressed to a group of high net-worth friends. Apparently, a group of individuals were trying to put together a sum of money structured as a loan to an employee of a high profile startup in Silicon Valley. The startup has been noted as "the next hot IPO" in the Valley, and an early employee had recently exercised all his or her stock options, which triggered a large AMT capital gain immediately on the difference between the current "fair market value" price and his option price.

Let's take a look at this from an employee point of view: as a private company employee, he's in a very bad spot, since he can't actually sell enough stock on the open market to pay the AMT due. If there was any way he could sell the stock at all, that's the correct way to go. Alternatively, he could attempt a private placement (i.e., sell it to accredited investors) in order to raise the funds. That would however require expensive investment bankers, etc., in order to structure a deal. So it's understandable that he would try to structure a loan using some stock as collateral.

From an investor's point of view, however, this is a bad deal. If the hot startup collapses instead of going public, then the investor loses all his money anyway, since there would be no recourse other than the aid private company stock, which would be worthless. If the hot startup goes public, the investor would have his upside limited to the agreed upon interest rate. The only way such a deal would be attractive was if the investor got equity as well.

Obviously, the best thing to have done would have been for the employee to have read my book An Engineer's Guide to Silicon Valley Startups several years ago, but since it was only published this year, it's understandable that the advice (which is not at all common knowledge) wasn't followed.

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