Equity is great. If you work for DataStax, you typically either get options or restricted stock units (RSU’s), which don’t vest until the company gets acquired or goes public. Your equity has been a big part of your compensation and probably your net worth, but after spending years helping DataStax build the most developer-friendly, all-in-one vector database you’re probably looking to monetize it.
The good news is there are a number of ways to do so pre or post IPO and even better, options to do so in some tax advantaged ways.
In this article, we’ll dig into 3 key tactical approaches you can take to maximize the hard-earned gains coming your way:
- Sell appreciated assets in a tax-exempt trust through Charitable Remainder Trusts. By doing so, it’s common to be able to take home 100% or more in after tax dollars compared to not using one and selling your assets in a regular taxable account.
- Diversify your shares with an exchange fund geared towards DataStax equity tax free. With this strategy, you can reduce your exposure to one asset and potentially use a loan to get liquidity today.
- Take a loan against your equity. You can collateralize some of your shares and get a cash loan that isn’t taxable. This allows you to get liquidity if you can’t or don’t want to sell your shares.
But first of all, let’s start with the basics of what tax planning is and how RSUs and options work.
What Is Tax Planning
Tax planning is a strategic approach designed to reduce a person’s or a company’s tax liability by leveraging various tax benefits and allowances. It’s about understanding the tax implications of your financial decisions, so you can minimize your taxes. Unfortunately, most people are unaware of how impactful it can be and that it can help you keep more of your hard-earned gains coming from your DataStax equity.
How Do RSUs Work?
RSUs are a type of equity compensation that public and late-stage private companies use to incentivize and reward employees. An RSU represents the right to receive a share of the company’s stock at a certain price. RSUs typically vest over a period of time and once they vest, the employee receives the company shares.
RSUs can be an attractive form of compensation for employees but the resulting tax can significantly reduce the value. If you receive RSUs, you will be subject to paying ordinary income taxes on the value of the RSUs when they vest and capital gains taxes when on any appreciation above the vesting value and the value you sell the shares.
Now, let’s delve into how stock options work.
How Do Stock Options Work?
Stock options are another common type of equity compensation. An option gives you the right to “exercise” — that is, to choose to purchase a share of the company’s stock — at a predetermined price (strike price). That price is typically fixed when you join the company and usually equals the startup’s current valuation.
When you exercise your options, you buy shares worth something. This is called the Fair Market Value (FMV), which changes over time (hopefully increasing!). However, even if the FMV increases over time from $1.00 to $10.00, you are still entitled to buy the options at the strike price when they are granted. That’s great — you’re paying less for the shares than they’re worth. But the government will tax you on any value you get from your employer an that ends up being the difference between the FMV of the exercised shares and the strike price you pay for them.
If you’d like to learn more on the topic, you can check our podcast episode on exercising options!
So now that you understand the basics, what are your possible strategies to monetize your DataStax equity in a tax efficient manner?
Need some help to understand the most convenient tax planning structure to monetize your startup equity in a tax-efficient way? Our team of tax-planning experts can help!
Strategies To Efficiently Monetize Your DataStax Equity
There are multiple ways to monetize your DataStax equity and, even better, alternatives to do so tax free. If you are seeking to maximize the value of your DataStax exit strategy, here are some smart options that can help create a plan that saves you money:
- Sell your shares using charitable remainder trusts
- Diversify through an exchange fund
- Take a loan
Below, we’ll discuss the benefits and risks of each strategy, as well as who might be best suited to use them.
1.Sell Your Shares Using a Charitable Remainder Trust
If you haven’t sold your shares you can use a Charitable Remainder Trust (or CRT) to sell your equity tax free. These structures are tax-exempt irrevocable trusts that work best for appreciated assets with unrealized gains, meaning that you have the opportunity to sell your shares tax free as long as you place them in the trust “prior” to selling.
With a CRT, you may gift equity to the trust, sell it and reinvest it tax free, and then receive a stream of income from the trust for a specified period of time. After the trust’s term ends, the remaining assets are donated to a charity of your choice.
By doing so, it’s common to be able to take home 100% or more compared to not using a CRT and just selling your assets in a regular taxable account, even after making a large donation to charity.
The benefits of using a CRT to monetize DataStax equity include:
- Tax-free growth: you can sell, avoid paying capital gains taxes on the appreciation to date and reinvest your equity tax free.
- Diversification: you can diversify your private equities tax free and invest in different assets
- Charitable deduction: you are eligible for a charitable deduction for a portion of the value of the assets in the trust, typically 10%.
The risks of using a CRT to monetize DataStax equity include:
- Loss of liquidity: You can’t pull all the assets from the trust at once; you may only withdraw a set percentage of the trust assets every year.
- Investment Limitations: You can invest in public and private markets, but can’t invest in things you personally benefit from and you can’t take on debt.
If you’ve already sold your shares, a Charitable Lead Annuity Trust (or CLAT) is another strategy that can help you reduce your tax bill and you can read more about it here. Among other options, you can also reduce your taxable income with other tax strategies such as renewable energy projects or Conservation Easements that can help you lower your capital gains tax bill after your sale.
2. Diversified Selling Through An Exchange Fund
A possible alternative could be to exchange your DataStax equity through an exchange fund. An exchange fund is similar to a mutual fund but, instead of contributing cash, you contribute stock. In return for trading in shares, you receive shares in a pooled exchange fund, which invests in other assets, such as valuable late-stage private companies, and real estate.
By aggregating the concentrated stock positions of many investors, an exchange fund allows you to replace your own concentrated stock position with a diversified basket of stocks of the same value and reduce portfolio risk, without triggering capital gains taxes.
Because the transaction is not immediately taxed, you can diversify without paying taxes upfront, putting off tax consequences until later.
The benefits of using an exchange fund to monetize DataStax equity include:
- Tax free exchange of illiquid assets: When you exchange DataStax equity for shares in an exchange fund, there is no taxable event and no capital gain taxes.
- Diversification: you can diversify your private equities by investing in a variety of assets.
- (Potential) Liquidity with loan: Because of the diversification of the fund as compared to a single company’s stock, this loan may have a lower interest rate than any loans that may be available to take directly against your equity.
The risks of using an exchange fund include:
- Holding Period: Exchange funds require a seven-year holding period. If you want to sell the equity before then you may face fees and additional taxes.
- Management fees: Exchange funds typically charge high annual (and potentially upfront) management fees, which can reduce the return on investment.
3. Take a loan
If you’re in need of liquidity and selling your shares using a charitable trust or diversifying through an exchange fund are not the best options for you, you can secure a collateralized loan using your DataStax equity. This approach will allow you to avoid triggering any capital gains tax.
Likewise, if you are close to a year holding period — but need money now — it can make sense to hold selling your stake in DataStax until you have reached the long term capital gains tax rate holding period (so you face lower tax rates when you sell).
In simple terms, a collateralized loan is a loan secured by an asset, also known as collateral. If the borrower defaults, the lender can seize the collateral to recover the loan amount.
If you’re holding equity in DataStax, it essentially means you own a piece of the company and this equity can potentially be used as collateral to secure a loan.
As an example, if you collateralize $1M worth of shares with a loan-to-value (LTV) ratio of 60% and a 20% interest rate, you can get a $500k cash loan (and the proceeds from the loan are not taxable). If your shares increase in value by 20%, you could sell half the shares you collateralized to pay back the loan and keep the other half of the shares. After this increase in value, the collateral is worth $1.2M which is why you would need half of it to cover your loan, leaving the other half for you to keep.
You can learn more about collateralized loans including a complete case study here.
Using DataStax equity to secure loans comes with several benefits, such as:
- Flexibility and Control: You maintain control over your equity, as you’re not selling your shares but only using them as collateral.
- Speed & Availability: The process is generally quicker compared to raising funds through equity sales.
- Tax-free proceeds: The proceeds from the loan are not taxable as capital gains.
Despite the benefits, there are downsides to this strategy, including:
- Limited by equity value: The loan amount you can secure is typically limited by the value of your equity. On top of that, the lender will usually only give you a cash loan up to a percentage of the equity you are willing to secure and they do this to cover their downside in case the equity loses value.
- Risk of losing equity: If your equity loses value, you risk losing more equity than expected. On other hand this can be seen as a way to monetize equity that you may not value highly or simply want to diversify away from.
High interest rates: Startup equity loans can have high interest rates (typically between 10-30%), which can make them expensive to repay unless you need the cash now or anticipate the equity appreciating rapidly.
What Strategy Is Best For You?
While all these strategies may be a good option for people who are looking to access cash from their startup equity without triggering taxes, the best way to monetize startup equity tax free will vary depending on your priorities and the options available.
There are two key decision points for these solutions: (1) Does the strategy apply to you? and (2) does the strategy serve your purpose, whether it is diversifying your portfolio, short-term liquidity, or otherwise?
Does the strategy apply to you?
All of the alternatives we’ll discuss are available only to shareholders — that is, individuals who have already exercised their options, converted their restricted units, or otherwise taken possession of actual shares. While Charitable Remainder Trusts are available to anyone who owns their shares, exchange funds and loans are available only to shareholders in a limited list of unicorn companies available here.
Does the strategy serve your goals?
- Charitable Remainder Trusts allow you to achieve liquidity and diversify holdings by selling your equity in a tax advantaged way to create more long term wealth.
- Exchange Funds allow you to diversify, offering exposure to a wider portfolio of companies. They do not require that you sell your shares and they do not create immediate liquidity
- Loans might be a good option if you need quick access to cash and either can’t sell your equity or want to retain control of it.
Understanding the available options and evaluating their applicability and alignment with goals will empower DataStax equity holders to make informed decisions on monetization, potentially maximizing the value of their equity in a tax-efficient manner.
We’ve built a platform to give everyone access to the tax and wealth building tools typically reserved for wealthy individuals with a team of accountants and lawyers. We make it simple and seamless for our customers to take advantage of these hard-to-access tax-advantaged structures so you can build your wealth more efficiently at less than half the cost of competitors. From picking the best strategy to taking care of all the setup and ongoing overhead, we make things simple. The results are real: We have helped create more than $1.1 billion in additional wealth for our customers.