The Share Option Bait & Switch
Shining a Light on Post-Termination Exercise Periods
When cash is scarce but share options are aplenty, startups strive to make up a portion of early employeesâ compensation packages with share options.
Most employees, even the most senior employees such as CROs often miss critical detail to help them put a true value on their share options.
As this market downturn takes hold, weâre going to see employees get fired, startups raise capital at lower valuations and weâre going to see many startups get sold for less than the valuation of their last round, and many will just disappear altogether - alongside tens of millions of vested share options.
These market conditions have serious implications for employee share option holders.
In this article, I want to shine a light on one specific topic: post-termination exercise periods. This remains a topic that founders routinely gloss over with employees.
First a brief overview of share optionsâŠ
Share options overview:
Share options exist as a makeweight in early employee compensation packages when cash is scarce. They are intended to encourage employees to stick around through the rough and tumble of the early years as âowners of the companyâ, when risk is at its highest, in the hope that those hard yards pay off in a life-changing exit (such as an IPO or major trade sale).
If it does go big those share options will hopefully be worth something significant to you. The headlines you hear are of early employees at companies like Google and Facebook turning into multi-millionaires at IPO, but of course, they are the outliers in the 1% that make it big.
So hereâs the first warning, based on the law of averages your share options are most likely going to end up worthless because most startups fail. It doesnât mean they wonât go big, but be realistic about your expectations.
Nowadays I treat share options as a potential unexpected rainy day bonus unless the company is very late stage and almost certain to IPO - but even then, in this market that presents no guarantee of a payout - keep reading to find out why!
Post Termination Exercise periods
Share options are typically granted on a 4-year vesting cycle with a 12-month cliff, this is what founders will routinely walk you through.
In short, this means you wonât get the right to buy any share options until youâve been at the company for 12 months, and the remainder typically vests in equal monthly increments over the following 3 years. So at the end of the 4th year, your original allocation will be âfully vestedâ, and in theory, theyâre yours to buy.
For as long as you are working at the company, it rarely makes sense to buy your share options although there are some tax incentives for doing so. Most employees prefer to wait until there is a qualifying event such as an IPO or trade sale.
If the IPO or trade sale is âsuccessfulâ the employee wonât need to pony up any cash to buy their share options. They will simply bank the difference between their original strike price and the strike price of the sale, minus the respective taxes.
However, there is one big caveat to consider here. Most employees donât make it from beginning to end. They either leave or get fired, itâs the nature of startups, they are hard, they are taxing and they need different skill sets at different stages of growth.
However, itâs standard practice for you to be forced to buy your share options within 90 days of leaving a company or lose them completely! This presents so many challenges to employees who have already committed to their side of the bargain!
The 2 biggest are:
a) You may not have the capital to buy those share options, and even if you have you may not be able to access it within 90 days of leaving, so youâll lose all of the share options you worked so hard to accumulate.
b) You may not yet be 100% convinced your company will have a successful exit, however youâre being forced to make that decision right at the point of departure!
To me, the failure to proactively highlight the post-termination terms of share options has always felt like a bait and switch move.
So, what choices do you have?
Firstly, this article is intended to make you aware of this stuff and to be your launchpad to dive deeper. Iâm not a financial advisor or an expert in all things share options, there are more comprehensive opinions and facts on this subject in the links at the foot of the article, please check them out.
Secondly, you donât need to be an expert on all things share options to know you need to negotiate the longest post-termination exercise period possible. 90 days is nothing short of a complete rip-off, especially for those that have fully vested their original allocation over 4 years of hard work and loyal service.
Amplitude CEO Spencer Skates blazed this trail a full 7 years ago, offering staff 10-year exercise windows, read his take here.
And Zach Holman has created a list of companies that have extended exercise windows, and thereâs a good amount that followed Skateâs lead and pushed to 10 years, hereâs the list: https://github.com/holman/extended-exercise-windows.
The good news, therefore, is that at least some founders are taking a stand. However, they remain in the overwhelming minority, unfortunately.
Final heads up
I hate to hit you with this to close out, but understand when all is said and done your share options are a class of stock known as âcommon stockâ, and most often investors have a class of stock known as âpreferred stockâ.
So, if an exit is not successful, for example, the company sells for $100m but has taken on capital of $100m or more to get there, as common shareholders your equity is likely worthless.
Itâs likely worthless because the preferred stockholders have special privileges, one of which sees their debt repaid (with interest) at any exit.
So when joining a company you need to know the amount of preferred stock that sits on the cap table (the table that breaks down who owns what stake in the company), to determine what the minimum exit price needs to be for employees to make a profit.
Thereâs much more to the whole realm of stock options at tech startups than this, but hopefully, this is your launchpad to dive deeper and ask smart questions.
Check out the links below for further reading.
Wayne
Advising: WayneMorris.co
LinkedIn: WayneMorris
Twitter: @waynegmorris
Newsletter sign-up: WayneMorris.me
Further reading:
Books on tech employee compensation:
https://equitycompbook.com/?affiliate_id=276534387
https://www.holloway.com/g/equity-compensation
Blogs
Common vs Preferred https://www.svb.com/startup-insights/startup-equity/startup-founders-should-know-preferred-stock
https://blog.pragmaticengineer.com/equity-for-software-engineers/
https://zachholman.com/posts/fuck-your-90-day-exercise-window/
https://github.com/holman/extended-exercise-windows
https://medium.com/@amplitudeHQ/employee-equity-is-broken-here-s-our-fix-ccf12dd961c7
Bettâs recruiting equity guide: https://insights.bettsrecruiting.com/equity-guide/