What happens if an option holder leaves the company?

Takeaway: If an option holder leaves the company, they generally have 90 days from the termination date to exercise their option. If they don’t exercise within that window, the option expires. Companies can generally extend the window in which the option holder can exercise but there are restrictions on when this can be done and it will convert an ISO to an NSO.

When an employee or consultant who holds stock options leaves a startup, the fate of their option depends on the specific terms of the option agreement and any applicable company policies.

In general, if the employee or consultant leaves the company before their option has vested (i.e., some of shares subject to their option has not vested), they typically forfeit those shares subject to the option that have not vested option. This means they will only have the right to purchase shares representing that portion of the option that has vested. The unvested portion of the option typically expires immediately upon termination of service. Remember, an option is a right to purchase shares of stock, not stock itself, so as the option vests, the employee or consultant receives the right to purchase more and more shares of stock (but they still have to exercise the option to purchase the stock).

If the employee leaves after a portion of the shares subject to their option has vested, they may have a limited time to exercise their option with respect to those vested shares, typically 90 days or less. If the employee fails to exercise their option during this time period, the option will typically expire and become worthless. If that happens, the shares that were subject to that option will return to the shares reserved for the company’s equity incentive plan and can then be issued to another employee or consultant.

In some cases, startups may have policies in place that allow employees to retain their vested options for a longer period of time, such as up to 10 years from the date of grant. However, this is relatively uncommon and is usually limited to situations where the company is offering some sort of severance to an executive or high-level employee. This is called extending the post-termination exercise period and there are limitations on when it can be done.

In summary, the fate of an employee or consultant’s stock option after leaving a startup depends on several factors, including the terms of the option agreement, company policies, and any applicable laws or regulations. It's important for both companies and employees and consultants to understand these factors and to have a clear understanding of what will happen to a stock option in the event of an employee or consultant’s departure. By communicating these policies clearly to employees and consultants and working with qualified legal and tax professionals, startups can ensure that their equity compensation policies are structured in a way that benefits both the company and its service providers.