The COVID-19 pandemic has upended life across the world and triggered layoffs across industries. Companies big and small have let go of employees as financial uncertainty looms.
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With layoffs among startups, there’s an additional component employees need to worry about if they’ve been let go: how to handle equity.
Part of the selling point of working for a startup is the idea of equity–the chance to share in the company’s success. Hopefully after a few years of putting in work, that equity becomes real wealth.
“Many people don’t even know this is such a big portion of their net worth,” said Wouter Witvoet, CEO of San Francisco-based equity planning startup Secfi. “If you’re laid off, you need to do something if you want to hold on to that stock.”
When an employee is suddenly laid off, however, equity often isn’t the first thing they think about, according to Carta chief financial officer Charly Kevers.
“If you don’t ask and you don’t know, 99 percent of companies won’t ping you,” Kevers said.
Carta helps both companies and employees manage equity, and says employees who are laid off need to be aware of what kind of equity they have, the time frame they have to exercise, the process to exercise and the tax implications.
Employees should know what kind of equity they have, whether it’s restricted stock or stock options, Kevers said. Restricted stock is a bit more straightforward because an employee gets it or they don’t. With a restricted stock unit, an employer promises to give an employee shares of the company’s stock in the future if certain conditions are met, according to Carta. Restricted stock awards function the same, except employees buy the shares on the day they’re granted.
Stock options are the chance to buy a certain number of shares of a company at a set price (the strike price) after those shares have vested. Incentive stock options (ISOs) and non-qualified stock options (NSOs) are the two major types of stock options, and the main difference is how they’re taxed, according to Carta (you can read more about stock options here). Employees should look into what kind of equity they have to better assess their situation, as well as how they could be affected by taxes.
One of the most important things an employee should do is check their post-termination exercise window, Kevers said. This means that employees should be aware of how much time they have to exercise their vested options.
Employees should check their option grant agreement for the window. The standard time frame for employees to exercise their options post-termination is 90 days, but companies could have shorter or longer windows. Some companies have extended their windows (companies can do so with board approval) to give employees more time to decide if they want to exercise their options and get the money together to do so.
“That’s a super important one to understand,” Kevers said of the post-termination exercise window. “Of course, the longer the better for the employee because it gives them more time to assess the situation.”
It’s important to keep in mind that even if a company’s post-termination exercise window is longer than 90 days, after 90 days incentive stock options convert to non-qualified stock options, and that changes the tax implications of them. We’ll touch more on that later.
And if an employee doesn’t exercise those options within the given time period, the options are forfeited back to the company.
Secfi, which raised $550 million in debt financing earlier this year, has worked with employees at companies Uber, Pinterest, Giphy and Tradeshift to help them unlock liquidity from their options and equity. Witvoet estimates that there is over $200 billion in “unicorn” employee equity and options currently in the U.S. market.
“Much of this will never be exercised and sadly, will likely ultimately be forfeited back to the company,” Witvoet said.
Understanding a company’s process for exercising options is critical, especially when employees have a limited time to assess the situation and make decisions.
“In this environment, where many companies make you sign paperwork and make you bring them a check, I would double-check the process,” Kevers said.
Processes vary from company to company, and if companies are doing everything manually, it gets more difficult to get the right piece of paper to the right person–especially now when many startups have gone remote because of COVID-19.
There’s a cost to exercising options, and if you have a “decent amount of equity,” that can amount to tens of thousands of dollars, Kevers said. Employees who joined companies early on have lower “strike prices,” or the cost of exercising an option, than employees who joined more recently.
“If you understand what type of option you have, that will guide you in understanding the tax implications of exercising your shares,” Kevers said. For both ISOs and NSOs, employees get taxed on fair market gains (the difference between the strike price when the options were granted and what the fair market value is now). Secfi’s Witvoet himself left a startup about two and half years ago, not realizing that exercising options triggers “a massive tax bill.”
“I had 90 days to come up with $1.8 million,” he said. “I lost everything, and the idea for this company was born.”
But timing of taxes is the key difference between exercising ISOs and NSOs, according to Kevers. With ISOs, an employee has to pay taxes when they sell the stock, not when they exercise their options. However, when they exercise ISOs, employees may be exposed to alternative minimum tax, which is dependent on income and other factors, Kevers said. NSOs are a bit harder because taxes are due the moment you exercise them.
Employees need to understand the fair market value of their stock, because that determines the tax implication, Kevers said. Understanding a company’s processes when it comes to equity is also important, because sometimes companies have to handle the tax component. Talking to a tax adviser would also be helpful, as they can better guide employees on the best course of action for their individual situations.
To exercise or not?
At the end of the day, employees need to ask themselves if they believe in the financial future of company they’re leaving. They could lose their equity if they lose their job, but at the same time they shouldn’t blindly go and exercise their options if they don’t believe in the company, Kevers said.
The more time an employee has to exercise their options, the better. If a lot of employees are affected by layoffs, they can collectively push the company for more time.
“In this environment, having more time is paramount,” Kevers said.
Reporter Mary Ann Azevedo contributed to this report.
Illustration Credit: Li-Anne Dias