Treating employees fairly
Yesterday, I read this article by Dan Primack that Pinterest is letting employees who have worked at least two years with the company hold their options for up to seven years from their exit date before being required to exercise. The money quote from co-founder Evan Sharp “The principle we’re operating under is one of fairness. 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.”
Sadly, “fairness" is a somewhat novel concept which is what makes this newsworthy. The standard provision for startup employees with stock options is that if they leave the company after the cliff - typically 12 months from their start date - they are required to exercise their options within 90 days from their exit date. Depending on the circumstances (number of options, strike price, and percentage vested), this can mean a substantial cash payment due to the company. It can also cause a hefty tax bill if the fair market value of those options is substantially higher than the strike price, thereby triggering a phantom taxable gain. It’s “phantom" because it’s only on paper and the individual hasn’t seen any financial benefit, yet the IRS recognizes it as a gain nonetheless. Many of us who have been around the startup world a while and have participated in significant growth of a business have experienced this pain. What’s wonderful about Pinterest’s decision is that it’s great for employees and minimally impactful on the company. Most startup technology companies recapture some portion of their issued options when employees leave and don’t exercise for whatever reason (usually because they can’t afford it), but Pinterest is saying that what the company has issued to employees belongs to the employees and that’s a beautiful thing. Another employee-friendly option treatment available to companies is allowing "early exercise". I’ve seen this done whereby companies will allow employees to exercise their options at or near their start date, ahead of the options vesting, and sometimes loan the employee the money to do so. This effectively becomes a cashless transaction for the employee, which is attractive since there’s no taxable gain as long as fair market value and the options strike price remain equal, and the clock starts ticking immediately on capital gains treatment, which requires two years from issuance and one year from exercise to qualify. In full disclosure, with this strategy, there are corporate tax implications to consider, the employee is taking a loan from the business that will eventually need to be repaid, and it does cost the company money. Generally speaking though, I hope more companies will follow in Pinterest's example and consider fairness as a guiding principle in treatment of employees and the equity portion of their compensation plans.