Allowing Departing Employees a Longer Stock Option Exercise Period

The well-known venture capital firm, Andreessen Horowitz, is now recommending to its portfolio companies that employees who hold vested stock options and leave the company have a much longer period following departure in which to exercise the option. As noted in the Andreessen article, the typical stock option will permit exercise within 90 days following departure. Andreessen is recommending that the period be extended to 10 years.

stock-optionsThe rationale for this change is that, upon departure, many employees simply do not have the cash needed to exercise the option and then to pay the taxes that are imposed upon exercise. If the company is still private, the employee will likely not have the ability to immediately sell the shares following exercise, which would otherwise solve the cash flow issue, at least as to the taxes. By extending the period in which the employee can exercise, there is time for the employee to raise the funds to pay the exercise price and taxes, or even better, for the company to be sold or go public, allowing the employee to immediately realize value on the option. Alternatively, the company might fail sometime during the 10 years following departure, in which case the employee will be happy not to have forked over money for a share purchase and taxes and nothing to show for it.

This is an unambiguously better deal for employees, though the Andreessen post details some tweaks companies can make to the grants to protect itself. One might wonder why a VC firm is advocating a pro-employee change in terms. I think the answer is that a 90-day exercise period poses significant practical issues for employees who don’t have much ready cash and it therefore could discourage potential employees from joining a startup and not practically being able to realize value in an equity grant. By extending the period to 10 years, companies can potentially increase the pool of qualified employees.