Cash and cashless methods for converting options to shares
- Cash exercise: the employee pays the total strike price out of pocket and receives shares immediately, starting the clock on any holding period needed for favourable tax treatment.
- Cashless exercise (sell-to-cover or net exercise): common at an IPO or acquisition, where enough shares are sold or withheld automatically to cover the strike price and any tax due, and the employee keeps the rest.
- Early exercise: some plans let employees exercise unvested options immediately, receiving restricted shares that the company can repurchase at the strike price if the employee leaves before vesting; this can start capital gains holding periods sooner but requires cash up front and carries the risk of losing that cash if the company fails.
Calculating cash costs and gains from option exercise
| Item | Cash exercise | Cashless exercise at exit |
|---|---|---|
| Options exercised | 5,000 | 5,000 |
| Strike price | 2.00 EUR | 2.00 EUR |
| Cash needed up front | 10,000 EUR | 0 EUR |
| Share price at exercise | 6.00 EUR | 6.00 EUR |
| Shares sold to cover cost | 0 | approx. 1,667 |
| Shares kept | 5,000 | approx. 3,333 |
Cashless exercise avoids the need to find cash up front, which is why it is the default method at most IPOs and acquisitions, but it means selling more of the newly vested options immediately and giving up any further upside on those shares, with the tax due calculated under whichever country's equity tax rules apply.
Practical issues to watch
- At a private company there may be no buyer for shares, so cashless exercise is often unavailable until an exit event.
- Exercising creates a tax point in many regimes even if the shares cannot yet be sold, known as dry income risk.
- Some companies offer loans or extended payment terms to help employees exercise, though these carry their own tax and legal complications.
- The Dutch 2023 rules let employees choose to defer taxation to when shares become tradable, directly addressing dry income risk for private company option holders.
Before exercising, employees should check the exercise window, the tax point in their country, and whether the company will support a cashless or net exercise process.
Before you click exercise: common concerns
- What is dry income risk?
- It is the risk of owing tax on the gain from an option at exercise, even though the shares cannot yet be sold to raise the cash to pay that tax, which is a particular concern at private companies.
- Can I exercise before my options have vested?
- Only if the plan explicitly allows early exercise. It typically results in restricted shares subject to the company's right to repurchase unvested shares if you leave.
General information for founders, not legal or tax advice. Thresholds and rates change, so confirm the current position with an adviser in the relevant country before granting.