Options refer to a type of equity award in which an employee is granted the right to buy a certain number of shares in the company at a predetermined price within a certain time frame. Typically, employees are not obligated to exercise their options. As we know, layoffs and terminations are part and parcel of the corporate world. In this regard, the term post-termination of an option is the right of ex-employees to exercise the rights they have been granted under the company’s stock option plan. The purpose of this article is to explain the concept of the post-termination option exercise window.
Post-termination option exercise window
Post-termination option exercise window is the period within which an employee who has been terminated or laid off or otherwise separated from service may exercise their option. Companies usually provide employees with 90 days to 10 years as the post-termination options exercise window. While the exercise window means the days within which the employee may still exercise their options.
However, after the expiration, the options become ineffective and void. The idea of the post-termination exercise window is to allow ex-employees and provide them with additional time to exercise their options. As a result, companies have embraced the post-termination exercise window to ensure that their ex-employees do not miss out on their vested options.
What is the Post-termination option exercise window?
The post-termination option exercise window is the time that ex-employees or terminated employees have to exercise their options. At the same time, this period is often referred to as PTE (post-termination exercise). The exercise window ordinarily lasts from 90 days to 10 years after separation or termination. At the end of the post-termination option exercise window, the options lose their effectiveness and are rendered void.
That is, after the exercise windows, the options have no effect. Generally, the option agreements have a clause discussing the post-termination option exercise window, thereby ensuring that the option holders or the employees do not miss their chances to exercise their options. Therefore, it is important for companies to ensure that their employees know the post-termination exercise window period and the effective date of the options.
Understand the background of the Post-termination option exercise window
According to the Internal Revenue Service (IRS) guidelines, the post-termination option exercise window acts as a solution to the problem of vested options (options that have been earned and vested before the employee has been terminated from their job). But why do you have only 90 days to exercise options?
As a matter of fact, after 90 days of the post-termination option exercise window (referred to as the short PTE window), if in case the employee wants to exercise their options, the conversion from incentive stock options (ISO) to non-qualified stock option (NSO) takes place.
In this regard, employees are required to pay taxes in order to buy and sell their stock. As a result, employees who are exercising their vested option during the post-termination option exercise window period do not have to pay taxes. Overall, the introduction of the post-termination option exercise window became necessary for many companies.
How does the post-termination option exercise window work?
Basically, when the stock options are issued, the employee receives the right to buy a number of shares at a particular price within a certain time frame. These options are then granted and become part of the employee’s compensation package. Companies generally offer a short PTE window, that is, 90 days exercise window. Furthermore, in cases of employees getting fired or terminated, this 90 days exercise window enables them to exercise their vested options.
As per the predetermined price, the option holder or the ex-employee must buy the shares within 90 days of the termination date. The process of exercising an option is simple, irrespective of whether the employee has been terminated or laid off, or has resigned. Essentially, the post-termination option exercise window provides a framework within which ex-employees can exercise their vested options.
What should employees know about PTE?
With respect to the post-termination option exercise window, it is important for employees to communicate effectively with their employers. The reason behind this is that the post-termination option exercise window will be discussed in the option agreement, and thereby, employees need to make sure that they are aware of the terms and conditions of the post-termination exercise window.
In addition to this, it is important for employees to check the date of issuance of their options in regard to the post-termination exercise window. Since the PTE period is limited to 90 days or 10 years, employees should make sure that they execute their options within the same time frame. However, it is advisable to execute the option well before the post-termination exercise window comes to an end.
What should employees do when getting a short PTE window?
The PTE period is an important factor when it comes to exercise options. For employees who are receiving a short post-termination exercise window (90 days), here are a few things employees can do:
- Choose the funding provider to work with – For employees receiving a short PTE window, it is important to choose the funding provider who can help you exercise your options. Since you do not want to miss out on your vested options, consulting the funding provider before the PTE expiration period will help you understand your options better.
- Accept it – The best way to deal with a short PTE period is to accept it and start to act on it. Additionally, it will help you to save time. However, it is important for the employee to be proactive about getting their options exercised and executing their plans in a timely manner.
- Consider other options – Converting from ISO to NSO is another viable option for those employees who are receiving a short post-termination exercise window. However, the problem with this option is that employees have to pay taxes for the shares that they buy and sell. Therefore, this option should be thought of as a last resort.
- Negotiate – If you are still not satisfied with the short post-termination exercise window issued by your employer, it is time to negotiate the issue and make your employers understand your concerns.
Post-termination exercise and options value
The employees who have been laid off or terminated have a period of 90 days to exercise their vested options before they lose the right to do so. As a matter of fact, it is important for them to understand that when they exercise their vested options, the value of the options might be changed. Now, this is why it is important for the employees to think about the value of their options before they exercise them under the post-termination option exercise window.
How do PTE windows affect the value of your options?
If you look at the basics, the value of a vested option is determined by the stock’s fair market value on the date of exercise. Now, what will happen to this value if you are given 90 days exercise window for your options under the post-termination option exercise window? Well, in this case, companies have the ability to reprice the options. In simpler terms, as per the current fair market value of the stock, the options get the price adjusted or repriced at that time. As a result, depending on the time when the options were exercised, the value of the options may change.
Standard PTE windows vs short PTE windows, how do they affect the value of options?
Typically, options always expire after ten years from the date of issuance. This is the standard post-termination exercise window. However, what if the employee has a short PTE window? Usually, most companies offer 90 days exercise windows, which means that it is a short PTE window. In other words, the time frame of a standard PTE window is 10 years, while the time period of short PTE windows is 90 days. Similarly, the value of options can be adjusted during the post-termination exercise window. This adjustment might change the value of the option.
How should employees have PTE conversations?
Employees should present their list of concerns and need for conversion to the company’s board. As such, potential employees can convince the board to grant their requests by showing that there are enough reasons for the conversion. Once the board approves the request, it can be put into practice.
How and why are startups considering and rethinking 90 days PTE windows?
Startups consider 90 days exercise windows unfair in the sense that it does not give the employees enough time to think about the post-termination exercise window. The flexibility to exercise options and the time frame are not in harmony with each other. As such, startups are rethinking post-termination exercise windows and 90 days PTE windows. Most of them have concluded that it is better to give employees more than 90 days to exercise any vested options they get.
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This article has discussed the post-termination exercise window, how and when it is used, and how it affects the employee’s vested options. Basically, it is important for employees to understand their options, the PTE period, and its effects on the value of their vested options. It will help them when they exercise their vested options under the post-termination exercise window. Eqvista provides financial services to companies, including stock option valuation, business valuation, and more. At Eqvista, they aim to help startups and companies succeed in their endeavors in regard to their financial needs. Visit Eqvista to know more.