
Pinterest lets employees exercise options 7 years after leaving - ropiku
http://fortune.com/2015/03/23/pinterest-employee-taxes/
======
habosa
This is really great, I hope more startups follow. In today's funding
environment startups that are angling for an IPO can stay private for a very
long time. Many companies are raising billions of dollars over 5-10 rounds
before looking to the public markets. That can mean a long time before
employees may choose to exercise their options.

Pinterest seems to recognize that if you put in two years at an early stage of
the company you deserve to share in future financial success.

I wonder why they made this move now? Specifically, I wonder if it came from
the executives, investors, or both?

------
atishd
Here are a couple of must-reads if you have received ISO, NSO, RSUs:
[https://equityzen.com/blog/understanding-rsus-like-your-
boss...](https://equityzen.com/blog/understanding-rsus-like-your-boss/)

[https://equityzen.com/blog/understanding-equity-
compensation...](https://equityzen.com/blog/understanding-equity-compensation-
for-startup-employees/)

Disclaimer: I'm with EquityZen. EquityZen helps employees get liquidity for
some of their options/shares before the company exits, so not only can they
afford the exercise, but also finance life events.

------
dlu
Hey look, it's something Sam Altman suggested, but happening in real life

------
staunch
Employees should start refusing to work anywhere that does it the "standard"
evil way.

------
mherdeg
Is that a better deal than Quora's "you may exercise options within 10 years
of grant date, whether or not you still work for the company"? Per
[http://blog.samaltman.com/employee-
equity](http://blog.samaltman.com/employee-equity) .

~~~
codezero
Really depends on the average tenure of the employees. In general, I think
Pinterest's is better. Also, Quora only offered that to employees recently, 5
years after the company started, so any employees that left before 2014 when
that was enacted wouldn't be entitled. It's possible the same is true for
Pinterest though.

------
mblevin
This is a great move and incredibly employee-friendly. We'll see if this is
the beginning of other companies following suit, but I doubt it.

As has been discussed before it's not the mechanics that matter here, but
rather the psychology of founders.

More often than not, there is the belief that even if you've been an employee
for 2+ years, if you're not "in it for the long haul" then you don't deserve
to hold on to your equity without paying for it in cash (or taking the tax
hit).

Not to mention there's very little incentive to amend these policies outside
of generating general goodwill.

~~~
amirnathoo
> Not to mention there's very little incentive to amend these policies outside
> of generating general goodwill.

There is now an incentive for other companies to follow suit since savvy
employees will value offers from Pinterest and other companies with this
policy much more highly.

It's rare that a company like Pinterest breaks ranks on things like this. I
hope they get a lot of goodwill from employees and applicants as a result.

------
throwaway3010
I brought this up recently in a negotiation and the response was that 5-10
year exercise timelines would hinder an acquisition.

Makes no sense to me, but is this a real possibility?

------
downandout
This ties into the whole issue with bloated valuations [1]. VC's are paying
for preferred shares and other deal points that make all classes of shares
appear to outsiders to be vastly more valuable than they are. Employees then
wind up paying inflated taxes on value that doesn't actually exist. The
valuations are mostly made up, but the taxes are very real.

[1] [http://www.bloomberg.com/news/articles/2015-03-17/the-
fuzzy-...](http://www.bloomberg.com/news/articles/2015-03-17/the-fuzzy-insane-
math-that-s-creating-so-many-billion-dollar-tech-companies)

~~~
dlubarov
But taxes are normally paid based on the latest 409a valuation, which can be
way below the preferred stock value from the latest funding round.

My impression is that companies rarely sell common stock to investors for that
reason (among others). Since investors valued the preferred stock, common
stock holders can ignore their massive valuation for tax purposes, and use the
409a.

~~~
downandout
Still, an appraiser brought in to do a 409a valuation wouldn't be doing their
job if they completely ignored the valuation from the latest funding round.
The value will be lower by a subjective amount determined by the appraiser,
but is still likely to be somewhat inflated if the preferred rounds were also
inflated.

------
throwaway85
Love this move. I, like many here, am feeling this squeeze after being
terminated from a startup in the 1B club. I need to decide to exercise or not.
I don't have the cash for the taxes.

Does anyone who has found buyers for their private stock without the company's
blessing care to post about their experience? Any recommendations for brokers
or investment groups that engage in such transactions but aren't predatory?
What snags did you run into and how long did the process take?

~~~
mavelikara
[http://www.esofund.com/](http://www.esofund.com/)

------
vinceyuan
Wow! Pinterest is so generous! In my previous company, I had to exercise my
options in 3 months after leaving. Now that stock's price increased by 50%.

------
Eridrus
Early exercise still seems like a better option than waiting if there is a
positive exit event since you get to pay capital gains rates, rather than
income tax rates if you hold it for more than a year.

It certainly depends on how much risk you're willing to take on though.

------
cbhl
Why is this better than Pinterest covering the tax bill for employees that
leave and/or are terminated? Is the latter impossible or impractical for some
reason?

------
JonFish85
One thing I don't see addressed is what this means regarding dilution and
such. With something like this, is the company more likely to dilute its stock
to try to dilute out people who have long since left the company?

If Joe Schmoe leaves the company with, say, .05% of the company, and in 7
years those shares would be worth $25m or something, wouldn't the company want
to dilute that person out in order to give their current employees value?

I guess I don't really see what the big deal is on this. It would seem to me
that the company would aggressively issue more stock to ensure that anyone who
left the company 7 years ago couldn't possibly control more stock than current
employees.

~~~
dlubarov
As long as the board doesn't do anything really shady, dilution generally
affects all shareholders equally. (Well, the effect can be slightly different
for preferred stock holders, but at least former employees will generally be
in the same boat as founders and current employees.)

------
caseyf7
It's great they are giving new employees some flexibility here. It would be
really hard to exercise a grant on an $11 billion valuation. Especially
without knowing the details of the liquidation preferences.

------
luckydude
We've been trying to figure out how to do this, does anyone have the legal
language that says how this works?

------
arenaninja
This is sensible. Bravo Pinterest

------
grellas
A few technical points:

1\. U.S. tax law _requires_ that incentive stock options (ISOs) have a 90-day
termination tail on them - that is, the options do not qualify as ISOs if they
are not issued under an enforceable agreement by which all vested options must
be exercised within 90 days of termination of employment or expire.

2\. As a direct result of point 1, the near-universal practice that startups
use when issuing stock options is to require employees to sign documentation
by which they agree that they lose even their vested options if they do not
exercise them within 90 days of their termination date.

3\. The original idea behind ISOs (the reason for distinguishing them from
"non-statutory" or "non-qualified" options) is that they can be exercised at
any time after they vest without triggering ordinary income tax for the
exercising employee at the time of exercise (subject to certain monetary
limits).

4\. However, the "benefit" note in item 3 above, though a very real benefit in
days gone by, is often illusory today because the exercise of ISOs requires
that the amount of the spread (difference between exercise price and fair
market value of the stock at the time of exercise) be included as an item of
AMT - meaning that a so-called "ISO" exercise can result in a huge AMT tax.
What this means is that an employee holding vested options in a startup whose
value has risen greatly faces a dilemma. "Do I exercise now, pay a huge tax,
hold only a piece of paper that may or may not be worth anything down the
road, and hope that the stock price holds? Or do I wait until a liquidation
event, exercise at that time, and thus eliminate the large tax risk of
exercising before that time?"

5\. Of course, many such employees chose to wait. If you cannot sell your
stock right away, it is a very high risk to pay a massive tax on an option
exercise only to wind up holding illiquid stock that may become valueless if
things don't go right. _This is no small issue._ People committed suicide
during the dot-bust era a decade or so ago after having made the wrong
decision.

6\. The problem is exacerbated by the 90-day expiration rule on employee
termination. It is one thing to wait and wait until the liquidation event. But
what if it is a long time in coming? Many employees are trapped in their
employment when they face the above dilemma because leaving their employment
will force them to exercise or lose potentially valuable options if they don't
exercise within 90 days of termination. Even worse, if their employment is
terminated by the company, they are put in the horrible position of losing
something they worked very hard for because of a seemingly arbitrary and
stupid rule saying that the options expire within 90 days of termination.

7\. Well, guess what, the rule _is_ stupid and arbitrary in many ways. Why?
Because, though the law requires that it be made part of any ISO grant, this
does _not_ mean that the startup cannot modify the agreement for the benefit
of the employee to eliminate the 90-day expiration provision and to give the
employee room to exercise for an extended period. What happens when the
company does this in spite of the tax rules? Well, it means that the option
loses its character as an ISO. But it does not lose its character as a legally
enforceable stock option. It just means that it is taxed as an NQO (non-
qualified option). So, in a worst case, the employee exercising an NQO gets
immediately taxed on the spread at the time of exercise. But, if that
modification gives the employee the flexibility to carry the options
unexercised but exercisable for a period going well beyond the 90-day period
currently defining expiration of such options, the employee can leave
employment, hold the options, and wait for such extended period (e.g., the 7
years discussed in the article here) before deciding whether to take the tax
risk of exercising and holding illiquid shares. And, if, in the interim, the
company does have a liquidation event, then the employee's dilemma vanishes
and he can exercise and sell right away in order to make the profit and pay
the associated taxes.

8\. The net result of the startup's agreeing to eliminate the 90-day provision
is that employees need no longer feel trapped in their employment once their
options have vested when the stock price becomes high. They can leave and
still keep the option of cashing in on their hard-earned options.

9\. So why don't most companies agree to such modifications? Their lawyers
will tell you that the law requires the 90-day rule and this is true but
misleading because that requirement can be violated in a lawful way that
simply changes the character of the options. Thus, if the parties can live
with the change, why not do it routinely? Well, I leave it to everyone to draw
his own conclusions. Perhaps startups want to keep their employees trapped.
Perhaps they are just listening to lawyers who insist on following the rules.
Or perhaps a board of directors does not feel it consistent with fiduciary
duties to give employees something that appears to be a gratuitous
modification that does not benefit the company. Whatever the reason, it
remains true that most startups choose to leave their employees trapped in
this dilemma without even giving them a good explanation beyond the fact they
agreed to the condition and that the the tax laws "require" it.

In any case, kudos to Pinterest for doing the decent thing here. It is indeed
all too rare to see something like this and they are to be congratulated for
it.

~~~
bsimpson
Thanks for the excellent write-up. How'd you become so knowledgeable?

~~~
davidu
He is a startup lawyer.

------
pcarolan
Way to set a good example.

------
r0naa
Wow. That's amazing, Pinterest is amazing! This is a great move: Pinterest you
rocks!

------
sandofsky
I'm curious about how this works. I thought, legally, ISOs must expire within
3 months of leaving the company. Assuming they've been issuing ISOs up to now,
are they converting them to something else, like NQSOs or RSUs?

~~~
caseyf7
ISOs are rare these days. If you have stock options, they are probably NQSOs.
ISOs had too many restrictions so most companies stopped using them.

~~~
ssorallen
What restrictions do you mean? ISOs are better for the employee because any
gain on exercise is not taxed as regular income. If the value is high enough
the employee might be subject to alternative minimum tax (AMT), but the
possibility of paying no tax is a benefit over NSOs whose gain is taxed as
regular income and is subject to tax withholding.

~~~
mtviewdave
> If the value is high enough the employee might be subject to alternative
> minimum tax (AMT)

I've never run the numbers, but my impression is that the AMT level is low
enough that AMT will be triggered for any exercise where the number and value
of options is meaningful.

>but the possibility of paying no tax is a benefit over NSOs whose gain is
taxed as regular income and is subject to tax withholding.

It's not "no tax". It's "deferred tax". But again, in the real world of
6-figure salaries and big mortgage interest deductions in Silicon Valley, the
deferral is probably mostly theoretical. Whereas the time limits on ISOs are
real and unavoidable.

~~~
ssorallen
Good point, "deferred tax" is more appropriate there. "No tax" is misleading.

You might be able to stay out of AMT by splitting ISO exercises across
multiple tax years, but that's splitting hairs. You make a good point that
this discussion is most interesting in cases where you'd likely be in AMT
anyway.

------
rokhayakebe
Why companies give early employees options to "buy" stocks? Why can't they
just be granted once vested and be done?

~~~
wpietri
Taxes, mainly.

If you are very early, when the company is worth nothing, then the company can
give you a big chunk of stock with no tax consequences. But once the company
is worth something, then getting the stock is income, and you have to pay
taxes immediately on the market value. It's not as good from the company tax
perspective, either.

It's also a problem in that if the stock is already valuable, giving you the
stock is the wrong reward structure. Companies are giving you options so that
you have an interest in the stock going up. Suppose when you show up the share
value is $40 and they give you 1,000 shares. if while you're there the stock
goes up to $60, you will have received something worth $60,000, even though
you only contributed to creating $20,000 of that. With options, they can give
you 3,000 options with a strike price of $40. If the stock goes up to $60,
then you still make $60,000 ($20 gain * 3000 options). But if it doesn't go up
at all, then your options would be worthless.

~~~
dlubarov
> you only contributed to creating $20,000 of that

That's an interesting way to think about it, but as long as the employee is
getting a base salary, the employer couldn't justify granting enough options
to achieve this goal of compensation being equal to (theoretical) value added.

If we consider base salary fixed, then options are more leveraged, but a
similar reward structure could be achieved by granting the same number of RSUs
and reducing base salary by the exercise cost.

~~~
wpietri
Sorry, I didn't mean to suggest that the goal was for compensation to be equal
to value added. I think the goal is for it to be proportional, or at least
more proportional than a pure stock grant would be.

------
choppaface
I've nearly gone bankrupt due to AMT on ISOs, and I've also been forced to put
up considerable money to exercise Non-Quals after leaving the company. I
definitely applaud Pinterest's move here. My former employer went public, the
top execs are still making a ton of money, and yet Finance still hasn't
implemented a similar post-termination plan. A lot of former colleagues are
still at the company due to 'mildly-golden' handcuffs-- the tax liability that
their options present is now large and complicated. Companies that fail to
adopt changes like these disadvantage themselves in a variety of subtle but
important ways.

What would be even better is if smaller companies / start-ups just did 83(b)
elections up-front (say on day one or year one upon cliff). Another (for
larger companies) option is to just offer RSUs.

The bottom line is that opportunities via tax law complexity are not
particularly _motivating_ to the majority of employees (i.e. ICs), and yet ICs
are the most likely to suffer near-bankruptcy due to unexpected income tax.
This is a nice step in the direction of transferring deserved wealth from 'the
top' to ICs, but there's still plenty of progress to be had.

~~~
beagle3
But for 83(b) to be feasible, the company has to be worth essentially zero.

Let's say you join a startup that the IRS can claim is worth $20M (based on
e.g. money raising valuation), and get 1% in RSUs worth $200K - depending on
your other income that year, the tax bill can easily be close to $100K (if you
made $100K in salary and live in NYC) for doing an 83(b), and it is still
likely to be worth zero being a startup.

And before you say "the fact it raised $2M on $20M makes preferred reflect
that value, not common which is still worth zero" \- that is a common
position, and the IRS almost never challenges 83(b) election valuations - but
are you willing to risk that they won't start challenging them? I gave up more
than one offer because I wasn't.

The bottom line is that the US tax system's taxing of virtual, unrealized,
unrealizable profit is insane - I am not aware of any other western country
that does that.

~~~
choppaface
Hmm, in my case the 83(b) election would have cost me about a quarter year of
salary, and the AMT I ended up owing was well over a year's worth of salary.
My original grant was small relative to the pool because I was a mid-stage IC
with essentially no prior experience. Perhaps for very early startups, or
those growing quickly through valuation raises, the situation is different. My
company only took on capital when we really ended it and it was cheap, but the
C-levels were pretty consistently getting offers (so the valuation grew
constantly, just not on paper).

Agree that the taxes on unrealized gains are insane, but they were intended to
protect the government's income source from different problems. Tech
compensation and VC has evolved dramatically since AMT was introduced.

~~~
beagle3
It's not that tech compensation and VCs evolved - it is that AMT was not
indexed to inflation (until 2013). When it was enacted, it applied to 155
families[0]. In 2008, it applied to nearly 4 million[0 again].

And I think sanity should not be judged by intention, but rather by action -
especially when we've had more than 40 years to evaluate.

[0]
[http://en.wikipedia.org/wiki/Alternative_minimum_tax#Growth_...](http://en.wikipedia.org/wiki/Alternative_minimum_tax#Growth_of_the_AMT)

edit: added link; thanks, choppaface

~~~
choppaface
Sorry, where's the citation / link for [0]? Very interesting.

~~~
beagle3
Oops, sorry. Edited to add
[http://en.wikipedia.org/wiki/Alternative_minimum_tax#Growth_...](http://en.wikipedia.org/wiki/Alternative_minimum_tax#Growth_of_the_AMT)

------
jpmattia
Looks like the Fortune article missed a big point: The exercise of the options
often requires a big pile of money to be paid by the leaving employee to the
company (ie, the strike price of the option. This occurs regardless of tax
issues.)

The advantage is seeing how well the stock performs, then performing the
exercise. If the company has gone public, then no real money needs to be put
up by the employee; Exercise and sale can occur in one fell swoop.

~~~
ssorallen
> Exercise and sale can occur in one fell swoop.

You lose the reduced taxes of long term capital gains if you wait, for
whatever reason, to exercise and sell the same day. You have to hold the
shares for 1 year + 1 day from the day you exercise for the subsequent sale to
be taxed as long term capital gains. For even the top tax bracket, the
difference is 20% in taxes.

~~~
jpmattia
That's correct, but remember that stocks go both up and down. Back in the
bubble, a lot of people got very burned: They tried to save the diff between
short- and long-term cap gains and ended up losing far more because of
variations in price.

To add insult to injury, many got nailed by AMT at the point of exercise. By
the time they figured this out, the entire grant would not cover the bill to
the Feds.

~~~
hkmurakami
Companies allowing current employees to exercise options 1+ year before a
liquidity event would prevent the tax issue. For a company like Pinterest that
is virtually guaranteed to have a good liquidity event, the risk of losing
your principal is minimal and you are likely being paid enough in salary to
afford the early exercise strike price.

~~~
beagle3
If the exercise event and the liquidity event are not in the same year though,
you might not have enough cash to pay the taxes. And if the liquidity event is
postponed forever (e.g., market crashes like it did in 2001 and 2008), you're
stuck with a big tax bill and no way to pay for it.

------
jedberg
FWIW, Netflix gives you 10 years. Despite the fact that I left a few weeks
ago, I still have about six years left to exercise them.

~~~
mrgriscom
Why haven't you? Aren't they public?

~~~
fsk
If the options aren't that far in-the-money, and he doesn't need the cash now,
it's actually better to wait to exercise.

If he exercises now, he only gets the raw value (current price - strike).

If he waits to exercise, he get the time-value of money and implied leverage
(he doesn't have to cough up the strike until he exercises), and the
optionality part (if Netflix goes below the strike, he can decline to
exercise).

He also can hedge by short-selling (and lock in a sure profit no matter what),
but you'd need a big-value account at a brokerage to hedge on favorable terms.

~~~
jedberg
> He also can hedge by short-selling (and lock in a sure profit no matter
> what), but you'd need a big-value account at a brokerage to hedge on
> favorable terms.

It's interesting, because I thought about this. When I worked for the company
I wasn't allowed to hedge, because you can't buy shorts in the company you
work for.

Now that I'm out I can, but the problem is, the company gave me such good
options there is no way I can buy an opposite option for the hedge. For
example, there is no retail short for more than two years, but my options
still have between 6 and 9 years left.

~~~
fsk
Buy the longest term put and roll the position when it is near expiration.
Don't fully hedge, just 1/2 to 1/6.

Also, don't write covered calls, that gives up too much upside. Instead, sell
outright.

------
t1m
The US should follow Canada's lead and not tax exercised options until the
stock is sold and _actually_ becomes income.

[http://www.taxplanningguide.ca/tax-planning-
guide/section-1-...](http://www.taxplanningguide.ca/tax-planning-
guide/section-1-businesses/the-taxation-stock-options/)

~~~
aero142
Even just only taxing it once it is sellable stock would be a huge
improvement. Getting stuck with a taxbill for something you can't actually
sell is ridiculous.

~~~
rsync
Phantom Stock:

[http://en.wikipedia.org/wiki/Phantom_stock](http://en.wikipedia.org/wiki/Phantom_stock)

"Phantom stock grants and vesting agreements align employees' motives with
owners' motives, i.e. increasing stock prices, while avoiding both taxable
compensation and the need to give recipients voting or other rights typically
associated with shares."

------
bagels
What argument is there for this policy against the employer, besides it's a
nice thing to do?

The employer benefits from having the options expire because people will be
less encouraged to leave with the current standard of expiring options.

~~~
pdpi
It reduces anxiety. Say you are slightly unhappy at your current job. On a
normal stock plan, you might start feeling that "golden handcuffs are tying me
to this company", which makes you feel even worse about your position, and
might actually precipitate you leaving.

Now, consider this policy instead. You'd get a feeling of "I could leave if I
really wanted to, nothing is tying me to this place". You get a greater
feeling of agency, of personal freedom. That relaxes you, and you feel more
comfortable staying with the company.

------
bobsky
Bravo. More companies that support this trend the better for the rest of us*
(the non founders cohort that is).

This movement only makes me appreciate the management and culture of
Pinterest; quite the opposite of the Zynga fiasco [1][2]

[1] [http://www.cnet.com/news/zynga-to-employees-give-back-our-
st...](http://www.cnet.com/news/zynga-to-employees-give-back-our-stock-or-
youll-be-fired/) [2] [http://www.cnet.com/news/zynga-uses-stock-options-to-
keep-em...](http://www.cnet.com/news/zynga-uses-stock-options-to-keep-
employees-put-report-says/)

~~~
brandonmenc
Zynga clawed back shares from underperforming founding executives, not rank-
and-file employees, right?

Not that you were, but that episode always seems to be painted as though
Pincus were yanking options away from sub-$100k/yr employees in the trenches.

disclaimer: I'm not defending Zynga in general, nor am I trying to take the
shine off of Pinterest's policy.

~~~
fsk
I think they clawed back unvested options from many employees, who had
unvested options with substantial value. That breaks the implied social
contract of a startup. If the company is wildly successful, they'll try to
claw back your unvested options, which makes startup equity even less
attractive than it would otherwise be.

Zygna isn't the only one that did this. Didn't Facebook also do this?

(So in a startup, you can be screwed with options in three ways. If the
startup fails, your equity is worth zero. If there's a low-value buyout, the
common shareholders can get nothing. If the startup is wildly successful, the
company will claw back your unvested options. Why join a startup for equity if
you're going to get cheated when you hit the 100x home run?)

Zygna got what they deserved. With changes to the way Facebook promotes their
feeds and the switch to mobile, they lost most of their market.

[http://blog.sfgate.com/techchron/2013/06/04/why-zynga-is-
fai...](http://blog.sfgate.com/techchron/2013/06/04/why-zynga-is-failing-in-
basic-napkin-math/)

~~~
rmc
This is the problem with the US's "at will" employment. It affects white
collar tech employees too. If you could only be fired for stated misbehaviour
(like in the EU), this wouldn't have been possible.

~~~
eru
But that's why they don't hire in Europe.

~~~
kbart
Who "they"? As far as I'm aware, all mentioned companies have EU offices too.

~~~
eru
I mean, companies in Europe hire less. If you can't fire people easily, you
think thrice about anyone you hire.

