Weekly Update #216: What the 90-day option exercise rule means for pre-IPO secondaries
What the 90-day option exercise rule means for pre-IPO secondaries
Employees that receive Incentive Stock Options (ISOs) typically have 90 days to exercise upon termination (or if they leave the company voluntarily, too). This can create cash constraints, as the option-holder may need to come up with cash, quickly, to cover the cost of exercise (and the ensuing tax bill the following year). Consider the following hypothetical scenario:
- UnicornCo has a valuation of $1 billion
- 15% of the company is owned by employees.
- UnicornCo has 500 employees.
- Half of the equity owned by employees has vested, and all the equity issued to employees was in the form of ISOs
- UnicornCo decides to layoff 10% of its staff (50 employees), to lower costs
In this scenario, we can calculate the value of stock at stake:
$1 billion * 15% owned by employees * 50% vested * 10% of staff laid off = $7.5 million in stock value
That means that in our hypothetical scenario, there are 50 employees that have 90 days to come up with a way to cover their exercise cost, otherwise they may forfeit stock that's worth $7.5 million!
If you think this scenario is uncommon, think again. Here are some recent headlines:
- NerdWallet just laid off over 40 people, including its VP of growth
- Medium lays off 50 employees, shuts down New York and D.C. offices
- Software development 'unicorn' [Github] to lay off up to 5% of workforce
- Unicorn startup Zenefits nearly halves its staff with layoffs
- AppNexus Lays Off 13% Of Its Workforce In Reorg
- HotelTonight Cuts 20 Percent Of Its Workforce
As a result, EquityZen often connects with ex-employees that are in this 90 day window. Selling a portion of their shares provides them with cash to exercise their soon-to-expire ISOs.
Fortunately, for tech workers, forward-thinking companies have found a solution for ex-employees, by offering to convert the ISOs into Non-qualified Stock Options (known as NSOs) upon termination. This removes the requirement of the 90-day exercise window, allowing the option-holder to exercise much later in the future. While Pinterest (Exclusive: Pinterest unpins employee tax bills) and Quora (as of 2014) were pioneers of this structure, many companies are beginning to follow suit. There is even an open-sourced list on Github of companies that extend the option exercise window.