If you’ve been lucky enough to keep your job or business, you almost certainly know someone who wasn’t so fortunate.
Thousands have lost their jobs as companies significantly reduce workforces to adjust to uncertainties and economic challenges created by COVID-19. Many of these people in tech are now faced with a number of questions, from how they’ll pay next month’s rent to whether they’re eligible for unemployment. One area that is particularly confusing is what to do if your compensation package was tied to equity.
Here are some ways I suggest approaching the issue.
Safeguard your equity
Layoffs have become part and parcel of the current economic crisis with unemployment figures skyrocketing to record highs as a result of COVID-19. From multinational conglomerates to mom-and-pop stores, everyone is feeling the impact, and the startup sector is no different.
Despite difficult circumstances, the silver lining for employees is that we have seen many management teams go the extra mile to help their teams, especially when it comes to equity. Compared to traditional layoff situations, companies in the COVID-19 era are offering generous extensions and accelerated vesting on their options, which is undeniably good news for employees with equity.
Typically, equity plans come with a 90-day exercise window after employment termination. That means that if you leave the company, you will have to exercise your options within 90 days or they go back to the company. However, lots of management teams have decided to extend these deadlines many years out given the circumstances.
While layoffs are not easy, it’s been great to see management teams doing the right thing when it comes to equity for their employees who have been laid off. Offering extensions is a benefit that employers should be offering their employees who have helped build the company.
If your company is not offering this, consider negotiating and asking for an extension. This is the right thing to do for employees who are now out of work and a paycheck for the foreseeable future. Both options do not require the company to pay cash at the moment, so there are few reasons a company should deny this request in this environment.
Consider exercising your options
Even if you are granted an extension to exercise your options, employees that hold incentive stock options (ISOs) should look into exercising their options now to maximize their equity’s value.
Many companies are offering extensions for option exercises. While this is great in that it gives employees more time to figure out their exercise situation, waiting past the 90-day window may have much bigger tax consequences that employees need to consider.
ISOs are much more tax advantageous compared to non-qualified stock options (NSOs). They are not taxed under standard income tax and if you sell the stock two years after grant date and one year after exercise date, you sell them as part of a qualifying disposition. In short, this allows you to effectively convert everything north of your strike price to preferential long-term capital gain rates.
As part of offering these tax advantages, the tax code has limitations on ISOs. Most relevant to us at this point is that the fact that you cannot have ISOs past 90 days after you are no longer an employee. This means that even if your company allows an extension on your stock options past the typical 90-day expiration window, your ISOs will convert to NSOs and lose their tax benefit.
This creates a potential planning opportunity that employees who have been laid off need to consider. If you feel good about the upside of the company, then you should consider exercising your ISOs today to capture the potential tax benefits rather than letting them convert to NSOs. Employees who wait risk putting themselves in the same difficult situation once the extension ends at typically less favorable conditions due to an increased 409A valuation.
Negotiate for equity during a pay cut or furlough
In light of the economic slowdown many companies have begun to cut costs. Reduced pay or furloughing employees has become the new norm as businesses of all sizes struggle to navigate these changing times.
It can obviously be concerning if you find yourself in this situation. But for startup employees, the COVID-19 crisis could provide an opportunity to negotiate your compensation package to make up for this decrease, and even set yourself up to prosper in the future.
Startups typically offer equity as a means of deferred compensation and as a way to incentivize employees to own a piece of the company they are building. The compensation is deferred as most startups are cash-strapped and cannot afford to pay you what a larger company may be able to.
If your company is now asking you to take a pay cut, or even take no pay during this time, you should consider asking for additional equity to make up for the lost compensation. While not all companies may be amenable to offering more equity, there is no cash outlay from the company’s standpoint, so it’s an efficient way for your company to compensate you for your sacrifice while preserving their cash.
In addition, offering more equity shows a commitment from management to their employees during this difficult time. It may be the win-win scenario for your company and yourself in the long-run so it’s worth having the conversation with management to discuss if this is available for you.
If your company does offer you more equity, make sure you ask whether the 409A (or fair market value) of the company is being updated. With revised forecasts given the COVID-19 situation, it may be possible for your company to issue your stock at a lower strike price if the company revalues its 409A.
Don’t be afraid to ask for help
I can sympathize with startup employees right now because I faced a similar situation when I left a startup that I had joined as employee number four and was forced to wave goodbye to the equity I had banked on.
If you want to take action on equity but don’t know where to start, now might be a good time to brush up on how your stock options work. As the economy begins to reopen, there’s a good chance we’ll see a rush for candidates in tech as companies compete to bring in some of the extremely talented folks who lost their jobs this week.
Those who have a good understanding of equity may be positioned for a big payday down the line.