Cook's Connections (Blog)

There is a fast growing movement underway in Silicon Valley changing an ancient stock option practice (ancient in Silicon Valley terms) which originally helped build VC backed startups but is now so outdated and misaligned with modern day private company times that Mgt teams/Boards across the Valley are mostly quietly changing the exercise periods of stock options board meeting by Board meeting.

The acronym is PTEP or Post Termination Exercise Period for Stock Option holders (primarily employees of private VC backed companies.

The issue is a forced 90 day exercise period once an employee decides to leave their company. If an employee can’t afford to pay the Stock Option exercise price + the taxes on any gains, the option which has been vested and earned by the employee is forfeited.

The crisis at hand is the unarguable facts that private companies are staying private much longer and valuations are soaring creating a huge economic disadvantage that greatly misaligns the original intentions of stock options as well as the meritocracy value systems that most leaders espouse.

In essence, we have a situation where the wealthy who can afford to exercise these options after 90 days have the opportunity to get more wealthy and vice versa.

I’ve been personally involved in much of this discussion from Board rooms to Panel Talks to private COO and CFO web/email groups.

I’ve recently posted my views to a few of these groups and have received such overwhelming agreement from peer CEOs, COOs, CFOs that it’s time to publish here as well to ensure the strong chorus is amplified.

Bottom Line: Stock Option times are a changing and it’s time to change with the times and be part of the leadership of creating a healthier economic reality for employees.

Here’s my post to those other groups that I’m sharing more publicly here:

Headline:

The private markets are catching up to ancient and outdated stock option practices.  Huge misalignment of fair compensation practices with regards to stock options.

Providing stock options to employees is a 30+ yr practice in which the underlying terms and practices have never changed/been updated.   4 yr cliff vesting, 10 yr option expiration, 90 days to exercise, only the 1st $100K of ISO’s can be exercised in any given year.  Only cliff vesting has been addressed in 30 yrs (it used to be annual cliffs)

The Problems in these stale practices are clear.   The Avg Private company is now staying private for 12 yrs (latest data).  30 years ago, the average was 4 yrs.   $100K ISO Exercise Limit has not changed with Inflation….should be in the $300-$400K range in today’s dollars.    Stock Option exercise prices used to be pennies or tens of cents.

Finally, the topic here, 90 days to exercise is so MISALIGNED, it remains the only form of compensation that can effectively be TAKEN BACK by those in power and with much deeper pockets.

We are dealing with a severe conflict of interest and “compensation strategy misalignment” and “fair dealings with total compensation” every time I hear a VC or a Board proclaim a “disadvantage to the company or to other shareholders” and the argument of having to expand the cap table because of the underlying Option Pool,

To set the facts straight, when the discussion is about extending the stock option exercise period, we are dealing ONLY with Vested Stock Options.     Stepping back and asking “What’s the Right Thing To Do Here?”, there is generally a failure to recognize that Vested Stock Options are “Earned Compensation”.    The employee worked “Sweat Equity” and typically took lower cash pay as part of their overall comp package.

And yet, how can it be that “Earned Compensation” can be swiftly taken back within 90 Days?   The party with the power says there’s a catch!    You are required to pay me a large % of the value of what you’ve earned (30-50% taxes) before I pay you your earnings?  You don’t have the cash to pay me before I pay you?    Too bad, I get to put those earnings back into my pocket?

Can anyone imaging treating other forms of earned compensation this way?  Your annual bonus?  Your annual commission?  Imagine being forced to pay the taxes on your annual bonus or commission upfront before the company pays you the actual bonus cash?  To add insult, imagine a company or board saying “If you can’t pay the taxes, you lose your bonus” and that gives us the opportunity to pay higher bonuses to others?  As ridiculous as that sounds, it’s exactly the practice that’s going on with stock options.

When framed this way, people should be up in arms about this practice especially with the complete lack of changes in the private marketplace now that companies are staying private longer, stock option prices (409a valuations) are the competition for attracting and retaining talent has never been higher.

So, in classic market condition corrections, there are now nearly 100 brand name private VC backed companies that have been proactive and have changed these ancient practices.  

The rest of the Private markets will follow sooner or later once they realize this is actually both a new retention tool and an alignment of interests tool.

github.com/holman/extended-exercise-windows

Extending exercise periods once a valuable employee hits 2 or 3 yrs and then extends a year for every year of service thereafter up to say 7 years is another retention tool not much different than “Refresh Grants”.

In the end, company’s, Boards, VC’s should never argue that they are “giving something” to these employees.  These employees EARNED this value by providing their valuable services to the company.   An employee shouldn’t have to be wealthy to acquire the value they’ve earned and certainly shouldn’t have this value taken away due to lack of affordability.

“The principle we’re operating under is one of fairness,” explains Pinterest co-founder Evan Sharp. “If you’ve made an important contribution to Pinterest, you should be able to keep that value. And that shouldn’t just be for people with enough cash to satisfy their tax liability.”

More Good Reading Here:

Forbes: top compensation attorney = author

https://www.forbes.com/sites/edwardzimmerman/2017/08/27/stock-options-vc-backed-startups-extend-post-termination-exercise-period-ptep/#630a895f5568

https://www.forbes.com/sites/edwardzimmerman/2016/08/23/how-startup-founder-stock-often-triggers-unnecessary-personal-tax-hits/#33150dfe562a

Quora

www.quora.com/Why-d…-Trieu

Pinterest in 2015:

www.foundersworkbench.com/start…years/

Steve Blank

steveblank.com/2019/04/10/startup-stock-options-why-a-good-deal-has-gone-bad/

NEXT STEPS: For those involved in a position to change your companies practices here, so your homework.

1) Read these links and others.

2) Talk to your legal counsel

3) Draft and propose the proper changes for your company to your Board.

This is long overdue…..it’s time to show leadership again in this very important compensation area.