Quick Answer for Employers
Issuing companies should plan ahead because option expirations often create significant but avoidable employee relations, tax, securities and administrative issues. For private companies, offering net exercise or participant loans may reduce employee stress but strain the company’s cash resources. For public companies, automatic exercise of expiring options is a popular solution.
Quick Answer for Executives
If your stock options are close to expiring, start by confirming the expiration date, exercise price, number of vested options, post-termination exercise period, and current exercise process. Then evaluate whether exercising makes financial sense, considering the tax cost, liquidity risk, and whether you want to own the stock. Before resigning, determine whether your exercise period will be significantly shortened.
When stock options are close to expiring, both the issuing company and the employee optionholder usually have decisions to make. Their interests may not always line up, but early planning can reduce confusion, preserve choices, and help avoid a last-minute scramble.
This article examines the issue from both sides: what optionholders should monitor before their options expire and what companies can do to reduce last-minute problems.
Plan Ahead Before Stock Options Expire: Advance Notice
You may not always know exactly when options will expire. A termination of employment, for example, can cause options to expire much earlier than the outside expiration date. Still, every optionholder can identify the outside date — the expiration date set at grant, most often 10 years for grants made in the United States.
In practice, expiring options tend to cause the most problems in three situations:
1. Private Company Options with No Sale in Sight:
Options may be nearing expiration even when no liquidity event is expected. Many optionholders and issuing companies hope for a sale in which vested options may effectively convert into cash. But some companies do not intend to sell, and for others the company’s growth and ultimate sale may extend beyond the option expiration date.
In those cases, the issuing company should anticipate the questions employees are likely to ask: How can I obtain liquidity? What happens if my options expire unexercised? Will the company offer another way to participate in future growth?
Employers may offer the following opportunities to help optionholders preserve the value of their options:
Establishing a stock repurchase program for all or a portion of the shares acquired through expiring options, providing employees with limited liquidity while allowing them to continue participating in the company’s growth. Some private companies offer active employees regular sale windows;
Making loans available to employees to pay exercise prices or supporting employees seeking outside financing, such as by providing financial statements;
Facilitating secondary sales by introducing investors to employees holding expiring options;
Supporting cashless or net exercise programs, which reduce employees’ cash burden while allowing them to continue participating in the company’s growth;
Allowing optionholders who own other shares to deliver those shares in payment of the exercise price.
In many cases, optionholders will still face tax withholding issues. When a cashless exercise mechanism is unavailable, such as for a private company, the company may be unable to commit its limited cash resources to an optionholder’s tax withholding obligations. The tax burden can also be substantial, with taxes due upon exercise potentially far exceeding the aggregate exercise price. Third-party lenders may provide financing to facilitate option exercises, but this is typically expensive. A third-party lender may also seek financial information from the company to offer better rates.
2. Private Company Options with No Valuation Available
Option expirations can create a distinct challenge: determining the stock’s value at the time of exercise. For a private company, this uncertainty may arise while the company obtains a third-party valuation for purposes of new option grants (often called a “409A valuation” because it is intended to satisfy Section 409A of the Internal Revenue Code). Uncertainty may also arise when the company is exploring a sale or has received an unsolicited offer. These situations can put the company in a difficult position because it may be unable to share valuation information, even though that information may affect the optionholder’s investment decision and the company’s tax withholding obligations.
In these circumstances, the parties may be able to extend the option’s term, arrange a conditional exercise, or agree on another process. Reasonable parties can usually reach a solution.
3. Shortened Exercise Period after Employment Termination
When employment ends, the optionholder may suddenly have only a short period to exercise, known as the post-termination exercise period, or PTEP. This can be especially difficult because the shortened timeline may be unexpected, emotions may run high, and open communication with the company may be strained.
With little time to save or raise funds, the optionholder must quickly decide whether to invest in the stock, gather enough funds to pay the exercise price and any required withholding, and deliver the required exercise notices. If a sale or other liquidity event remains far away, the decision can feel especially risky. Planning ahead is key to reducing the stress of this moment.
Avoiding Surprises: How to Plan Ahead
Companies do not always notify optionholders before their options expire. Employers devote varying levels of resources and professional support to managing equity programs, and even well-intentioned companies may lack systems that provide clear, timely notice.
What Should Optionholders Do Before Stock Options Expire?
Optionholders should review their equity holdings, identify when their option awards are set to expire, periodically monitor those dates, and understand the PTEP that may apply in different termination scenarios. Some equity administration platforms make gathering this information easy. If the information is not readily available, optionholders may need to monitor expiration dates themselves by requesting copies of the plan, grant agreements, and exercise procedures from a company representative.
If financially possible, optionholders should plan for the cost of exercising well before the deadline. That planning may include saving funds, exercising in affordable installments (especially to reduce exposure to the alternative minimum tax and create capital gains opportunities for incentive stock options), or negotiating alternative ways to pay the exercise price, such as loans or cashless or net exercise.
Funding the exercise is only part of the decision. Optionholders must also decide whether they want to invest in their employer. If so, some third-party lenders may finance option exercises, but arranging that financing also requires time and advance planning.
What Can Employers Do Before Options Expire?
Companies can also help address the exercise challenge. Even financially savvy, savings-minded optionholders may need help from their employer, especially when stock values are high.
Employers should help employees answer these common questions:
How much will it cost to exercise the options?
Will exercising trigger tax withholding or the alternative minimum tax?
Is there a way to exercise without paying the full exercise price in cash?
The answers depend on the option type, the plan documents, the company’s procedures, and the optionholder’s personal tax situation.
Employers may explore the following options with legal and tax advisers:
Providing tax and exercise education to help answer these common questions;
Allowing optionholders to deliver shares they already own as payment;
Replacing expired options with grants of phantom stock (for tax reasons, the replacement grants should be unvested);
Extending the post-termination exercise period;
Adopting an automatic exercise program or plan feature. In a public company, this approach can work well if the rules are highly automated and closely monitored, helping ensure that departing employees and current employees with expiring options do not lose the value of their options.
A Note about Public Companies:
Public companies face different legal and practical constraints — as well as opportunities. For regulatory reasons, employee loans are not permitted for officers and, in practice, are typically unavailable to all employees because of compliance challenges. Public companies also face governance expectations and disclosure requirements that may deter them from considering requests for special accommodations.
Public companies, however, typically offer cashless exercise programs, reducing the need for optionholders to provide cash for the exercise price and taxes — a challenge that often affects private companies. Although public company shares generally offer greater liquidity, blackout periods can still limit optionholders’ sell-to-cover opportunities. Unless an employee has a trading plan in place (often called a 10b5-1 plan), the employee may be unable to exercise through a process involving public sales. Establishing a 10b5-1 plan in advance can be a valuable strategy.
Early Planning Preserves Options
There is no one-size-fits-all solution to pending option expirations.
The best approach is to identify the deadline early, understand the exercise mechanics, evaluate the tax and investment risks, and seek guidance well before the window closes. For companies, advance planning can reduce employee frustration and avoid rushed decisions. For optionholders, it can preserve choices that may otherwise disappear.