The Lack of Options for Startup Employees’ Options

A solution a few people have discuss would be to allow the unexercised options to remain under the employees name, but the company would be able to re-issue the options to new employees at a higher strike price. When the new employee exercises the option (assuming the value has risen), the company would get the strike price of the initial unexercised option and the former employee would get the difference between the higher strike price and the original lower strike price.

For example:

Employee A is granted options with a $1.00 strike price.

Employee A leaves the company after a few years but doesn't exercise the options

The company re-issues the option grant at $3.00 to Employee B

Employee B decides to exercise and pays the company the strike price.

The company would keep $1.00 and Employee A would receive $2.00

This seems fairer than the current structure and allows Employee A to still benefit from the options if the company continues to do well without him. Of course, implementation would be much harder/complex.

From the piece: "Fundamentally, we are here because companies are choosing to stay private significantly longer than the time period for which the four-year option vesting program was originally invented. It’s a historical anachronism from the days when companies actually went public around four years from founding. Today, however, the median time-to-IPO for venture-backed companies is closer to 10 years."

This is just plain wrong. We are here because Congress decided to close "loopholes" in the Tax code associated with stock options.

Before they did this, you could exercise your option, at the strike price, and if you did nothing else you owed no tax. It was only when you sold the stock you held, were any gains or losses computed, and the taxation was based entirely on how long you held that stock (long term or short term).

Now the reason they did this, was that giving someone stock options in a publicly traded company is very much like paying them cash. And so the IRS wanted to "capture" from those people income tax they would otherwise avoid. And you could see it if someone paid you $1, and gave you an option for 1000 shares with a strike price of .001 but a current trading value of $50. You paid income tax on $1, used that to exercise your 1000 shares, and a year later you sold them for $50,000 paying only long term capital gains. Clearly avoiding the income taxes on $50,000 they really "paid" you.

They closed this loophole with "alternative minimum tax" and which basically a rule where if someone gives you a lottery ticket you have to "pretend in some alternate universe" that you won the lottery and actually pay the taxes you would have paid if you had, and only when its clear that you couldn't possibly have won the lottery can you treat that as a tax "loss", but they don't give you that money back, rather they let you write it off slowly over years and years and years. And as you can probably tell I've written a number of angry letters to my congresscritter about it, especially in the context of an illiquid asset like pre-IPO startup stock.

Without all the tax shenanigans options would work just fine. When you left the company you'd exercise them, owe no tax, and hold them for later. If you happened to be in a universe where "later" they were tradable, or you figured out a way to trade them non-publicly, only then would you have to pay taxes on the gain.

The trick is getting tax law changed to exclude artificially valued shares (which all non market traded securities are) from the AMT and income calculations.