Stock options are how cash-starved tech, and life sciences companies large and small can most easily recruit and retain talent. Stock options are also an excellent tool for bigtech and bigpharma companies to align the optionee’s interest with the business.
Even if you are excited to start a new chapter of your career, leaving a job is stressful for anyone. Before you pack up your things and send your goodbye emails, make sure not to forget about your stock options.
A stock option provides you the opportunity to buy a stock share in the future at a set price. So, when you decide you’re ready to buy the stock using an option, you exercise the option. When you exercise your option, you pay the cash price in the option contract. In some cases, you can “net exercise” the stock options, with the number of shares corresponding to the value of the exercise price for all the shares deducted from the number of shares issued. If the cost of exercising your option is below the stock’s market value and there is a liquid public trading market, this can be very lucrative. If you exercise and sell, you will need to budget for the exercise price and the ensuing taxes due on the gain (which will be ordinary income unless you exercise and hold for at least one year). Options that qualify for ISO treatment will be taxed differently than options that are “non-qualified.”
If you have stock options with the company you are leaving, you should quickly act (or not act) with your eyes wide open. Your company is not obligated and may not remind you about any stake you are entitled to, much less the expiration date of the award. If the company is privately owned, you likely cannot turn your stock into cash just yet. But sometimes, equity can turn into wealth, and if your company does well, you could end up earning more from your equity than from your salary.
Often, employees miss out on a lot of money because they are unaware of vesting terms and the post-termination exercise period of their stock options. The post-termination exercise period refers to the period after the end of your service with the company, during which an option must be exercised before it expires. Often, vested stock options expire if they are not exercised within the specified timeframe after service termination.
Typically, stock options expire within 90 days of leaving the company, so you could lose them if you don’t exercise your options. Most companies accept this as standard practice based on IRS regulations around ISOs’ tax treatment after employment ends. However, many have recently challenged it, and some companies have even extended this window. But overall, if your vested stock options are not exercised before the expiration of the post-termination exercise period, they expire and are canceled. And in many cases, you will miss out on tax advantages by waiting because ISOs turn into non-qualified stock options (NSOs).
Keep in mind the necessary common stock option provisions and critical dates that departing employees should know. First, be mindful of your applicable vesting dates — in general, you have rights only to stock options that have already vested before your date of termination. For startups, stock option grants are often subject to time-based vesting over a period of four years, with 25 percent cliff vesting on the first anniversary and the remainder vesting monthly after.
On the date of your departure, you are typically allowed to exercise the vested portion of your stock option awards, and you’ll forfeit the unvested amount. So, if you are planning to leave your job, review the details of your vesting schedule. And, you may even decide to delay your departure to ensure that you do not leave before the vesting of a substantial portion of your option grant. Secondly, you should know your applicable post-termination exercise period, which typically starts on your last day. Because of tax and securities laws and accounting rules, it is common for stock options issued by private companies to have a term of up to ten years from the date of grant. But, the post-termination exercise period is usually shorter than the applicable term of the stock option grant.
When you negotiate the terms of your exit, some companies will entertain acceleration of vesting of the grant, or the potential extension of the exercise period of your option beyond the 90 days to some longer time period during which an exit could occur or that you could afford to pay the exercise price. Some companies are extending post-termination exercise periods beyond 90-days to seven years as a matter of policy for all employees. But if the expiration date happens and you have not exercised, you may be leaving money on the table.
Please thoroughly review your stock option documents, including your stock option plan, a notice of grant, and an option agreement. This will help inform you of the rules for vesting and post-termination exercise. Your stock option documents are the only reliable sources that ultimately determine your contractual rights.