Equity compensation has become increasingly popular among employers as a way to reward employees with stock in the company. I’m a big advocate for this type of compensation because it can be a powerful tool in building wealth.
However, many people don’t fully understand how equity compensation works or how to manage it effectively. While I’ve written in the past about different types of equity comp, today we’re focusing on a common question: what happens to stock options once you leave your job?
To answer this, there are a few important factors to consider:
- Vested vs Unvested Stock
- Types of Equity: RSUs, ISOs, NSOs, and more
- Your Risk Appetite
- Tax Implications
Let’s break these down.
Vested vs Unvested Stock
Not all stock options are the same. When you leave your company, your options will fall into two categories: vested and unvested.
Vested options are the ones you’ve already earned according to your vesting schedule (often a 4-year plan with a 1-year cliff). These are yours to keep—sort of. For example, if you have RSUs that have already vested, you’ll still retain those.
Unvested options are the ones you haven’t earned yet. Unfortunately, unless your company offers a special exception, those options are forfeited when you leave. The same goes for unvested RSUs—they simply disappear, and you won’t receive any value from them.
I’ve known people who’ve lost out because they didn’t realize how much of their equity was still unvested. It’s a good idea to review your grant agreement before you give notice. Taking an extra 3-6 months to ensure a large vest can sometimes be worth it—or you could negotiate with your new employer to match the stock compensation.
The 90-Day Clock for Options
Here’s where it gets a bit tricky and where proactive planning can make a significant impact.
For your vested options, most companies give you a 90-day window after leaving (called the Post-Termination Exercise Period or PTEP) to decide what to do with them. If you don’t act within this period, you could lose them.
For ISOs (Incentive Stock Options), if you don’t exercise them within 90 days, they typically convert into NSOs (Non-Qualified Stock Options), giving you an additional three years to exercise them. In this case, you may lose some tax benefits, as ISOs don’t trigger taxes unless they’re subject to the Alternative Minimum Tax (AMT). However, NSOs are taxed immediately upon exercise, and you’ll owe regular income tax on the spread between your strike price and the market price.
To Exercise or Not?
Let’s consider an example: You have 1,000 vested options with a strike price of $10, and the stock is now worth $50.
You have a couple of options. You could exercise your options, paying $10,000 to purchase the shares, which would result in a spread of $40,000 (you may owe AMT taxes here).
Alternatively, you could do a cashless exercise, where you sell enough shares to cover the cost of the exercise and taxes. If the company is public, you can do this easily, as you have a known value for your shares. In private companies, however, this is riskier, as you may end up paying to exercise the options without knowing if or when you’ll be able to sell the shares.
In a public company, it’s often more straightforward: You can either cash out immediately or, if you’re optimistic about the company’s future, you can exercise and hold onto the shares for long-term capital gains treatment.
But when it comes to private companies, things get complicated. You could choose to:
- Exercise to minimize tax liability, knowing there’s a level of added risk
- Let the options convert to NSOs, which gives you more time (three years), but comes with more tax implications
The decision ultimately depends on your personal circumstances.
Key Considerations:
- Risk Tolerance: How much risk are you willing to take?
- Liquidity: Do you have enough cash on hand to afford the cost of exercising options, especially if the company is private?
- AMT Impact: Will you be subject to Alternative Minimum Tax?
- Company’s Prospects: Do you believe in the company’s long-term success?
- Your Financial Goals: What do you hope to achieve by exercising the options?
It’s crucial to make a plan well in advance of your departure so you can make the best decision for your future financial health.
Final Thoughts
Leaving your job doesn’t mean your stock options are automatically gone, but you do need to act quickly. Whether you choose to exercise your vested options or let them convert into NSOs, the key is to understand the timeline, the tax implications, and the risks involved. Planning ahead can save you a significant amount of money and ensure you make the most of your equity compensation.
Remember: If you don’t take action within 90 days for ISOs, they’ll become NSOs. So, don’t delay—take control of your options today!