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This makes it sound like shares are far too risky from a tax standpoint to be worth it for anyone but founders. Startups are risky enough from a career standpoint without having the threat of personal bankruptcy hanging over employees' heads. Is this generally the case or is there a way out?

Options for employees usually work well in spite of the tax risks. Most employees get ISOs and exercise them without incident and without AMT. They take some modest financial risk in paying for the stock but these amounts are usually small.

Problems arise if you are terminated in your employment (or quit) and you face a 90-day window to exercise options that will otherwise expire in a company that is promising but not established. For example, a former client of mine did this (after being terminated) in a solar startup in which he had been employed and got hit with a $600K tax bill. The company is all the rage among some VCs but completely unproven in the market and the stock itself has no liquidity and will not likely have any for years to come. If the company makes it big as hoped, this man will be rich; if not, he will have run the risk of a personal bankruptcy.

I would say that extremely risky situations occasionally arise involving employees and options but these are the exception and not the rule. In most cases, the risks are limited and manageable and the use of options is an excellent vehicle for the employees as a key financial incentive. The key, though, is to know what you are doing and to understand the risks before undertaking them. Beyond that, it is up to each individual and his own sense of risk tolerance.

With ISOs, for most of us, the best approach is not to exercise until you're ready to sell. In short, as long as your options aren't about to expire, sit on them. However, if you leave the company, you normally have 90 days to exercise. This can make for a nasty problem if the company is not yet publicly traded; you will need some other assets to be able to pay the AMT. In such situations, perhaps the best course of action is not to exercise unless the company is clearly on track for a "liquidity event" (an IPO or acquisition), as evidenced by strong revenue growth, AND you have another source of funds to pay the AMT.

Don't think of the AMT as something that could strike without warning, like lightning. It is absolutely possible to protect yourself against it as long as you understand the rules, or get advice from someone who does. Make sure to look into it before exercising any options.

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