Net Exercise Stock Options Explained: A Comprehensive Guide

Net Exercise is a cashless method of exercising stock options, most commonly used at public companies. Instead of paying cash to purchase your shares, a portion of your vested options is withheld to cover the exercise cost. This allows you to receive the remaining shares without needing upfront capital.

At public companies, Net Exercise is standard because the stock is publicly traded. At private companies, however, it must be explicitly offered by your employer. When available, the company typically uses the current 409A Fair Market Value to determine how many shares are withheld to cover the cost.

How Net Exercise Works

To perform a net exercise, start by calculating your total cost to exercise: number of options x strike price

Next, determine the current Fair Market Value (FMV) of the shares. For public companies, this is the current stock price. For private companies, it is based on the most recent 409A valuation.

Then divide the total exercise cost by the FMV. This tells you how many shares must be withheld (or sold) to cover the cost of exercising the rest.

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Example:

1,000 options with a $1.00 strike price and a $5.00 FMV

Exercise cost = 1,000 x $1.00 = $1,000

$1,000 / $5.00 = 200 shares sold to cover costs

You receive the remaining 800 shares

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🔔 Note: In a net exercise, the shares used to cover the cost are technically sold, which can trigger a taxable event. That sale may result in ordinary income based on the difference between the strike price and the FMV (the "spread").

In addition, depending on the type of option, you may owe taxes at exercise:

• NSOs: Subject to withholding tax on the spread.
• ISOs: May trigger the Alternative Minimum Tax (AMT) based on the spread at exercise—even if you didn’t sell any shares.

Benefits and Drawbacks of Net Exercise

Benefits

• No upfront cash required: Net exercise allows you to acquire shares without paying out of pocket. A portion of your vested options is withheld to cover the cost.
• Simple execution: At public companies, net exercise is typically fast and standardized. If your private company offers it, the process is usually straightforward as well (depending on how your company handles option exercises internally).
• Lower Financial Risk: Since you’re not investing cash, your downside is limited if the company’s value drops.

Drawbacks

• Fewer shares retained = less upside: You give up part of your equity to cover the cost, reducing your long-term ownership.
• Tax Liability Remains: You may owe taxes based on the full value of the exercised shares, even without receiving cash.
• Limited Availability: Private companies must explicitly allow net exercise, it’s not always an option.
• No Liquidity: This is not a sale. You get shares, not cash, so if taxes are due, you still need a way to pay them.
• Selling at a low price: In a private company net exercise, you're effectively "selling" shares back to the company at the 409A valuation, which is typically a low, conservative estimate. As a result, you may give up more equity than if shares were priced closer to true market value.

Cash vs Net Exercise

Based on the earlier example of 1,000 options with a $1.00 strike price and a $5.00 FMV at exercise, the table below shows how net gains differ at various hypothetical exit prices. For simplicity, taxes are excluded, since both methods would generally face the same tax treatment on final sale.

Overall, net exercise reduces your financial risk if the company underperforms, but limits your upside if the stock performs well.

Tax Implications

Net exercise doesn't eliminate taxes, just the need to pay cash for your shares. The tax impact depends on your option type:

NSOs

The spread between the strike price and FMV is taxed as ordinary income at the time of exercise.

With a net exercise, your company will likely withhold enough additional shares to cover this tax, reducing the number of shares you receive even further.

ISOs

Net exercise complicates ISO tax treatment. The portion of shares withheld (or sold) to cover the cost is considered a disqualified disposition and taxed as ordinary income on the spread (like the NSOs). The remaining shares you keep retain ISO status but may trigger the Alternative Minimum Tax (AMT).

Importantly, companies usually do not withhold for AMT, so you could owe taxes out of pocket even though no cash changed hands at exercise.

Eligibility: Can you even net exercise?

Net exercise can be appealing, but most private companies don’t offer it. Stock options are intended as a retention tool, and a cashless exercise makes it easier for employees to leave without forfeiting their equity.

When it is available at a private company, the downside is that you're essentially selling shares back to the company at the 409A valuation, a conservative number that often undervalues your equity. On top of that, you may still need to pay out of pocket for taxes, making the “cashless” exercise not so cashless after all.

In many cases, you're giving up a large chunk of your upside just to avoid paying out of pocket.

A more efficient alternative is to work with ESO Fund, which provides non-recourse funding to help you exercise without giving up shares or putting your own cash at risk. Fill out the form below to get started.