Can I give an employee a longer period to exercise their option?
Takeaway: Yes, so long as it is done within the appropriate time frame, which is usually before the option expires (e.g., 90 days after termination). Be judicious about doing this, however, because doing it for one person can make other people expect the same treatment.
When an employee leaves a startup, they typically have a limited amount of time to exercise any vested stock options they hold. This period is often 90 days (or 3 months) or less, and if the employee fails to exercise their options during this time, the options will typically expire and become worthless. However, in some situations, startups may choose to extend the post-termination exercise period (“PTEP”) for stock options. Here's why and how they would do it.
What is the standard post-termination exercise period?
Most companies’ equity incentive plans provide that the standard post-termination exercise period is either 90 days or 3 months. This means that if a service provider (e.g., employee or consultant) leaves a startup and holds a stock option, they have 90 days or 3 months to exercise the vested portion of that option or it expires. This can be an important consideration to service providers in evaluating their equity compensation because, often, startups are not close to an exit event when the service provider leaves and they have to decide whether to come out of pocket to pay the exercise price for their option, which can be a significant expenditure.
To alleviate some of this burden, companies can extend the post-termination exercise period to give the service provider more time to evaluate whether to exercise their option.
Why extend the post-termination exercise period?
The primary reason companies consider extending PTEPs for vested stock options is that the option holder earned the right to purchase those shares and requiring them to purchase the shares within 90 days after terminating their service doesn’t give them a sufficient opportunity to receive the value of their equity compensation. The most common situation in which a PTEP is extended is when an executive or high-level employee leaves the company and is negotiating a severance package. It is not a common practice for rank-and-file employees.
Why shouldn’t companies extend the post-termination exercise period?
There are a couple primary reasons companies may be hesitant to extend PTEPs:
Dilution: Depending on how many shares the company has extended the PTEP for, there could be a lot of shares that are “stuck” in an option held by someone no longer helping to build value for the company. In this situation, the company may need to add more shares to its equity incentive plan, which dilutes existing stockholders (including founders and investors).
Taxes: For option holders that received an incentive stock option (ISO), extending the PTEP beyond 3 months after termination will automatically convert their option to a nonstatutory stock option (NSO). This may result in less favorable tax treatment for the option holder.
How to extend the post-termination exercise period
The specific process for extending a PTEP depends on the provisions in the company’s equity incentive plan but, generally, the power to extend PTEPs resides with the plan administrator (which for 99% of startups is the company’s board of directors). So, usually, the company’s board of directors can extend the PTEP before the option expires. There are timing restrictions on when the board of directors can do this, and it is important to consult an experienced legal advisor to ensure that any PTEP extensions are completed within the requisite time periods provided in your company’s equity incentive plan and under applicable law.
Conclusion
Navigating the complexities of PTEPs requires careful thought and prudent decision-making. While extending the PTEP for vested stock options can be advantageous to option holders, it must be managed judiciously to avoid adverse effects such as dilution of shares or less favorable tax implications. Keep in mind that extending the PTEP is often a tool reserved for high-level employees during severance negotiations and is typically not a widespread practice. However, each situation is unique and, with the help of an experienced legal advisor, startups can make the best decision that aligns with their overall equity compensation strategy and corporate structure.