If you're familiar with the tech industry, you’ve no doubt heard of company stock being a big part of compensation. In light of recent reports of Stripe dealing with a $3.5B tax bill and why they’re fundraising for it, we wanted to write a post explaining more details on why stock options expire and what you should know about it if you’re considering a tech offer with a private company.
What are stock options?
Stock options, with regard to compensation, are contracts that allow an employee to buy a specified number of shares for a fixed price (AKA ‘strike price’). They are also the most common way startups will offer equity compensation.
An employee with a stock option grant will not be a shareholder until they exercise the option, which means purchasing their shares at the strike price. The strike price is the fixed price-per-share set in the option agreement.
The idea is that the company will entice you with cheap stock options, you’ll work for the company, make products, etc. which will increase the value of those options, then when you go to exercise them, you’ll come out with a potentially huge profit. It’s why early employees of companies like Amazon, Microsoft, etc. can get so much money.
Of course, there are a lot of other things to consider, such as expiration (which we’ll go over), liquidation events, base salary, etc. We can’t get into all of it now, so we’ll focus on stock expiration first, given its timely nature.
What is a stock expiration date?
All stock options come with an expiration date, which is the date by which the options must be exercised (i.e. the shares must be purchased) or they will expire and be worthless.
In the US, it’s industry standard that stock options almost always expire either 10 years from the date they were granted. In rare cases, there may be different timelines though, such as the post-termination exercise window, which we’ll discuss later.
Why do stock options expire?
The IRS mandates that stock options have an expiration date of 10 years from the time of grant. Back in the day, it took a startup around 4 years to hit a liquidity event, meaning owners of the options could exercise and sell their shares, so most silicon valley startups never anticipate hitting the 10-year mark without that happening.
What happens when stock options expire?
When stock options expire, they become worthless. This means that if you don't exercise your options before the expiration date, you’ll lose the opportunity to purchase those shares as your pre-agreed on strike price.
It's important to note that if you leave the company before your options expire, you typically have a limited window of time (usually 90 days) to exercise your options as well. If you don't exercise them during this window, they will expire. This is referred to as a post-termination exercise window, which essentially reduces the expiration timeline from 10 years to 90 days as a result of you leaving the company.
How can you avoid letting your stock options expire?
The best way to avoid letting your stock options expire is to exercise them when you can. Often times, companies will have vesting schedules that allow you to exercise a percentage of your options after a certain amount of time.
It's also important to understand the tax implications of exercising your options. When you exercise your options, you’ll owe taxes on the difference between the strike price and the market value of the shares, just like normal stocks. So if you exercise them as soon as you can, you might be okay with taxes since the difference won’t be as high, but you might be missing out on huge gains later on if you held them. Remember that your strike price is locked in, so waiting a little bit longer won’t mean you have to pay more for them later on.
What is a post-termination exercise window?
The post-termination exercise window is a period of time after an employee leaves their job, during which they can exercise their vested stock options. Typically, this window lasts for 90 days, but it can vary depending on the company's stock plan and the terms of the employment agreement.
If you’re considering leaving your job while you have vested stock options, you should review the stock plan agreement to understand the terms of the post-termination exercise window. There will be details provided in there about the timeline, strike price, available options, etc. If you stand to lose or gain a lot, we highly recommend consulting a financial advisor.
Why is Stripe fundraising for this?
In the interest of their employees, it seems Stripe is teeing up a buy-back of their shares from early employees. This allows employees to sell their shares for liquidity and use that to pay for the tax bill, meaning they’ll see the gain with minimal tax hits.
On the other hand, Foursquare has opted to let their options expire for their employees without doing anything to help out. Meaning all the early and former employees will not see any gains related to their options.
Conclusion
It’s important to be aware of stock options and their impact as you consider joining a startup. It’s a hot startup market right now, given big tech’s recent layoffs, and one of the risks is stock expiration. We highly recommend consulting with a tax professional and weighing your options carefully.
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