So You're Leaving Your Startup Job...

Nat Disston
May 29th, 2014

Preparing to leave a job and starting a new one is already an overwhelming task. Leaving a startup job may mean even extra hurdles given the additional complexities in compensation (equity). We’re here to help you know what you’ll need and when you’ll need it. This includes understanding your rights as a shareholder and employee, the documents you should have in your possession, and the time frame to act accordingly.

Understanding Your Equity Compensation

Startups use equity to compensate employees because they typically don’t have a lot of cash and this further aligns the employees’ and company’s interests to build a strong, lasting business. However, equity compensation is treated as a sensitive subject and wrapped in difficult to understand legalese. For this reason, employees don’t always have a clear understanding how they are paid in this way and don’t have sufficient avenues for liquidity. We’re here to help you with both. If you need to know more about your equity compensation, we’ve outlined incentive compensation in more detail here.

Typically, startup employees are given ISO’s (Incentive Stock Options) on top of their base salary. This is an option to purchase a set number of shares that vest over a give time period. The standard "vesting schedule" is 4 years, with a 1-year cliff and monthly vesting over the remaining 3 years (more about that here). The important thing to note is that when preparing to leave a startup job and you have ISO’s, you will only have 90 days from your last day of employment to exercise your options, or else you will forfeit them all back to the company.

The Documents You Should Have Regarding Your Equity Compensation

Here is a list of documents that are issued to you at time of your employment. You should keep them in your personal records but know you should always have access to them via the company. These are documents pertinent to your holdings and material to your rights as a shareholder. Don’t hesitate to ask for them. Here's a basic overview, and we've created a detailed outline of each Equity Compensation Document here.

  1. The Company’s Equity Incentive Plan
    • The plan for granting and exercising options as well as any restrictions regarding your shares.
  2. Grant Documents
    • Documents by which the company grants you your options
  3. Exercise Documents
    • Includes number of options you’re exercising and the exercise price
  4. Shareholder Agreement
    • Governs the terms of your share ownership
  5. Share Certificate
    •  Physical and digital copies of your share ownership
  6. Company By-Laws
    • These may include provisions that restrict your rights as a shareholder. If the company won’t give it to you, it is fair to ask for written confirmation that there is nothing that materially impacts your rights.
  7. Separation Letters
    • Once you leave your job, this will outline how many options have vested, your exercise price, and time you have to exercise. Importantly, it will state your formal termination date, i.e., when your 90-day clock to purchase your options starts ticking.

Chances are you are paid in ISO’s (Incentive Stock Options), which expire 90 days after you leave the company, after which you can no longer purchase your shares.

Understanding the Taxes around your Equity Compensation

The misconception around equity compensation is that it’s like a free lottery ticket. Equity compensation is great, but there are a few things to be mindful of to actually own your equity, particularly around the tax treatment. When considering the purchase of your options, you should know that you are subject to the AMT (Alternative Minimum Tax) in the same year you exercise your ISOs. If you are not in a position to handle a potentially larger tax bill, you should check how the AMT might impact you. However, buying your options as they vest starts the clock on your capital gains tax. 

After exercising your options you may choose to sell some or all of your shares. Should you plan on selling, there are a few more things you should know about the taxes you will face after a sale. If you sell your shares within 1 year of exercise date or within 2 years of grant date, they will be taxed as ordinary income on the difference of share price on exercise date and the sale date. If you sell your shares after 1 year following exercise date and 2 years after grant date, they will be taxed as long term capital gains on the difference of share price on exercise date and the sale date. We’ve provided more detail on tax considerations here.

What About Your 401K?

If you participate in your company's 401K plan, you're going to have to make a decision on what to do with it going forward. You have 4 main options: 

  1. Leave assets in current employer's plan
  2. Move assets to a rollover IRA
  3. Roll over the assets to your new employer's plan (if allowed)
  4. Withdraw the funds altogether.
There are multiple factors to weigh and each scenario is different depending on your personal situation and preferences, as well as what your employer's plans allows. The important things to consider and determine in any case are: 
  1. Understand your employer's plan's rules
    • Can you keep the funds in the current plan or move them?
  2. Understand the fees involved in each scenario
    • What expenses and fees does your plan have versus an IRA? 
    • Does your current plan have regular administration fees?
  3. Compare the tax impact of any move
  4. Determine your own preference for managing these assets
    • Do you want them under one roof or spread across multiple?

General Good Practice

On a less technical note, it's important to consider the human element of leaving your startup job. Startups are fragile businesses that haven't hit a steady state of success. You were given equity compensation because you were considered to be a key builder to that future. Your exit requires them to spend extra time recruiting, hiring, and training a new employee. Not only is this is an expensive and time consuming burden, but it's an emotional one as you were likely part of a small team that grew close. Make sure to leave on good terms and allow for a smooth transition for your successor. You can help in the recruiting and training process, wrapping up your affairs, and individually working with your colleagues to make a smooth transition. This will pay dividends down the road for your personal network as well as company support for matters such as liquidity.

Important References

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