The prominent social media company Pinterest recently took a bold step by allowing terminated employees to retain vested options for up to seven years after termination – a significant upgrade from a standard 30-to-90-day expiration period.
An employee-friendly action like this can increase morale. Historically, companies were reluctant to allow former employees to retain their stock options once they voluntarily left the company. This created a disincentive for employees to leave, and free up the opportunity pool for new, motivated employees to make a contribution. Pinterest’s action is a unique philosophical change – to let people who want to leave, leave – without losing the equity benefit they earned for their past services. The company is sending a message that they only want employees who want to remain and be fully committed to its vision. Pinterest may have identified a competitive differentiator in the tight technology job market, and it will be interesting to see if other companies add this feature to their plans.
But there are hazards. While an extended exercise period is a significant benefit for terminated employees, in the future it may create large pools of unexercised, in-the-money options.
Allowing valuable options to expire leads to unfortunate losses for both the company and employee. First, the employee (or former employee) does not receive the value of the benefit. In addition, the company does not receive the capital it would have received upon option exercise, or for non-qualified options, the tax deduction that was anticipated at grant date.
There are many reasons participants might let in-the-money options expire. Terminated employees may believe their grants ended when their employment did. Certain participants don't realize that the expiration date for a grant was accelerated due to their leaving the company. Sometimes, options that are underwater at termination later have value when the market price substantially increases. Unfortunately, many participants don't understand exactly what an option is or how to use it. Some don't even remember having received options in the first place, and, of course, some participants may just lose track of time.
Proactive research and calling campaigns can not only mitigate former employee complaints that they were not informed of the outstanding award, but also improve former employee attitudes toward the company’s brand. The company receives the additional benefits of added capital, and often a tax deduction for the value of the exercised option.
For clients considering the Pinterest model, it’s important to partner with an administrator that can maximize the results for all participants, as well as the company.
Andrew Schwartz (CEP, CPA), has more than 12 years of experience with the administration and taxation of equity compensation.