employee equity compensation in tech startups
September 1, 2021
August 30, 2021
September 1, 2021
August 30, 2021
It was late 2016, and Ali Khajeh-Hosseini faced an all-too-common decision for startup employees: Should he exercise his stock options on his way out the door?
Four years earlier, he had launched a promising startup called ShopForCloud, which he sold to RightScale six months later for a combination of cash and incentive stock options (ISOs). He fully understood how his RightScale ISOs would work — he’d vest his stock options over four years, and would eventually unlock the ability to buy those options with cash.
But now, instead of buying those options, he was considering walking away and letting them expire. He and his cofounders were preparing to launch a new startup called AbarCloud, and they wanted to invest their personal money in getting the new company off the ground.
Like the majority of startups, RightScale offered its employees a 90-day exercise window — after the group left the company, they’d have just 3 months to buy their stock options, or lose them forever.
Khajeh-Hosseini ended up buying a small percentage of his RightScale stock options, and allowed the balance to expire. Two years after he made that decision, RightScale was acquired by Flexera.
If the company had offered Khajeh-Hosseini and his team a longer exercise window, they would have likely been able to experience the upside from that acquisition.
“It definitely feels like stock options are broken right now,” he said.
Startups ask their employees to take an initial gamble, he said — join us and (oftentimes) take a smaller annual salary in return for stock options, which might create life-altering upside in the future if we all work hard and grow the business together.
What’s less-discussed is the second gamble most startups ask employees to make when they’re leaving the company: Please mail us a check within the next 90 days for thousands — and in many cases, hundreds of thousands — of dollars to buy the stock options you’ve vested.
Some employees don’t buy their stock options because there’s too much risk that the startup will fail, while some don’t buy their stock options because they don’t have the cash on hand, or don’t want to tie up so much money in a single asset.
And others, like Khajeh-Hosseini, want to invest in their next company.
In a recent opinion piece, Khajeh-Hosseini urged his fellow founders to consider extending their stock option exercise windows beyond 90 days. At his latest startup, Infracost, he and his fellow cofounders decided to give their employees 10 years to exercise their stock options.
That extra time lowers risk for employees — they wouldn’t need to spend cash immediately, and could wait to see if their former employer raised additional rounds of funding and continued to grow. If the company went public or was acquired, the employees could still share in some of the upside they helped create through their earlier work.
But that requires a conscious choice from the startup’s leadership.
“The founders of companies have to make this decision, ‘Do we want to do this 10-year exercise window?’ and the tradeoff is more dilution for everyone, including the founders and all the later-stage employees who come on board,” Khajeh-Hosseini said. “But that’s the tradeoff we made at Infracost, because that’s how we would have wanted to be treated if we were employees joining this company right now.”
A small but growing number of private companies have adopted longer stock option exercise windows, notably Coinbase, Kickstarter, Patreon and Pinterest.
Employees who exercise their ISOs while still employed at their company (or within the first 90 days of leaving their company), can experience federal tax benefits. Any ISOs that they’re still holding after 90 days of leaving their job get automatically converted to non-qualified stock options (NSOs), which are taxed differently.
Still, paying potentially higher taxes on NSOs is better than losing your stock options altogether, Khajeh-Hosseini said.
For tens of thousands of startup employees working for companies that continue to enforce a 90-day exercise window, Secfi can provide the non-recourse financing needed to buy those options instead of losing them entirely. Learn more about exercising your stock options with Secfi’s Options Exercise Tax Calculator.