In recent months, thousands of employees have been laid off from high-tech companies. Many of them hold options to purchase shares of the companies they worked for. Is it possible to exercise these options after being laid-off? How do you check if it is economically viable and how much tax will these employees have to pay? With the help of attorney (CPA) Racheli Guz-Lavi, Managing Partner at the firm Amit, Pollak Matalon & Co. and a part of its tax department, and together with Guy Elbaz, GM of EquityBee Israel, we prepared a guide that will help those laid off from high-tech companies decide what to do next.
What is the window of opportunity to exercise the options?
First of all, it is important to know that the time period for exercising options for employees in case of layoffs is usually 90 days, which is how the option plans are usually formulated. Today, in the current market situation, laid-off workers may have difficulty finding a new job and also, the exercise price of the options may be higher than the current value of the stock. Therefore, employees may completely give up the options they have. If the employing company wishes to extend the exercise period beyond the date set in the original option plan (usually 90 days) the tax liability jumps from 25% (capital tax) to up to 47% (marginal tax liability).
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Exercising options is an economic decision
“The decision whether to exercise or give up the options is a financial decision and it is a decision from the investment world. In fact, every employee who decides to exercise their options is making a decision to invest in the company they left – and the first question to ask is how much do you believe that the company you left will succeed and reach a successful exit (sale) or a successful IPO and are you willing to risk the investment amount (the cost of exercising the option) in favor of the chance that it will actually happen?” says Elbaz.
As with any investment, alongside the chance that the startup will succeed, there is also risk, as most startups fail. What makes the decision whether to exercise the options even more complex is the state of the markets. The uncertainty that exists makes it difficult for even the most experienced investors to make investment decisions.
The options available to you in this relatively short period of time are:
1. Exercise the options by investing the exercise amount and become a shareholder in the company (high risk of losing the exercise cost; along with the potential for high profit).
2. Exercise the options by receiving financing and becoming shareholders in the company (there is no risk of losing the exercise cost; along with the potential for a smaller profit).
3. Give up the options (zero risk – zero chance).
The questions you should ask yourself to understand which option is right for you:
1. Do you believe that the company will succeed?
2. Is the redemption amount such that you can afford to lose it if the company fails?
3. Does your profit potential match the level of risk?
4. Do you have a better investment alternative?
To answer these questions, Elbaz suggests thinking about the following issues: “As employees of the company until recently, you should know how it is doing. True, there were layoffs, but do you think the company is on the way to a good place ? Will it continue to grow in revenue? Is it on the way to profitability?”.
It is not recommended to exercise options at a cost that will put you in trouble if you lose it, so it is important to ask yourself whether exercising the options will come at the expense of something essential for you and how quickly you will be able to save such an amount again.
How to estimate the profit potential
The most difficult task is to estimate the profit potential in exercising the options. In the case of an exit, the profit will be derived from several variables:
1. Preference for preferred shares “liquidation preferences” – As employees you hold options for ordinary shares while the company’s investors have preferred shares that give them preferential rights – for example, priority in the distribution of assets and funds. Therefore, it is important to understand what the rights of the preferred shares in your company are. “The mechanism that has been common in recent years allows investors to choose between receiving the amount of their investment back or their share of the profits according to the percentage of their holdings. In such a mechanism, as long as the exit amount is higher than the amount of the recruitment, shareholders, including the employees who exercised options, will benefit from the profits. There are more aggressive mechanisms, such as for example priority for shareholders of 3 times the amount of their investment,” explains Elbaz. “The more the distribution mechanism leans in favor of the preferred shares, the more significant an exit is required for the employees who own ordinary shares to see money from it.”
2. Sale price versus exercise cost – In a successful exit from which employees register profits, the profit will be calculated as the difference between the stock price and the exercise cost of the option. For example, if it costs you one dollar to exercise an option per share, and the share sells for $10, your profit before tax is $9 per share.
3. To create scenarios first you need to know how much the company you left is worth today and the price per share. For example, according to the last fundraising round, the company raised according to a value of $500 million and a price of $5 per share. In a scenario where the company is sold at its value today – how much will you earn? You can make a comparison with similar public companies, check according to which multiplier they trade and what their value is.
Try to evaluate what are the investment alternatives you have. Do you have a better investment for the money, one that is perhaps less risky, has more potential, more liquidity? In addition, examine what your investment portfolio looks like today and if you have an investment portfolio that is spread between different investments, are you ready to invest the necessary investment amount and be exposed to an illiquid, high-risk investment in one company.
“A large part of the decision of what to do with the options is derived from the personal circumstances of each employee, so there is no right answer for everyone in this regard and it is important to consult, to get as much information as possible, ” says Elbaz.
Is it possible to save the options without paying for them?
“For this purpose, the options plan must be examined. If the granting company has anchored a cashless mechanism (net exercise), it will be possible to reduce the value of the exercise supplement from the value of the option, thus exercising the options without requiring additional expense. For example, if the employee is entitled to 10 shares worth 1 shekel and the exercise surcharge per share is 0.5 shekels. In such a situation, the employee will be able to receive only 5 shares (instead of 10) and this without being required to pay an exercise surcharge. Applying this mechanism in the case of a public company involves obtaining approval from the tax authorities,” says Guz-Lavi.
Can the options be sold or transferred?
In a private company, it is likely that no buyer will be found to purchase the options. Also, transferring options to another person is considered a sale, and will require payment of tax. In a public company, as a principle it is possible to exercise the stock options and sell them on the stock exchange.
Can the vesting period be accelerated?
If the company that granted the options wishes to speed up the vesting dates, it is required to make an explicit request to the Tax Authority and receive a taxation decision according to which they will consider the shortened vesting date as a new allocation date for all shares for which the vesting date was changed. However, if the vesting period is changed following the employee’s departure, the tax that will be paid on the allocations that have not yet reached their vesting date before the change is higher (up to 47%).
Can the company reduce the exercise price of the options?
“In light of the economic situation, some companies whose share value has decreased in the recent period want to reprice and reduce the exercise price of the options, so that the new exercise price will reflect the current share value. In such a case, the company needs to approach the Tax Authority as soon as the repricing date is approved, as that will be considered a new allocation date,” says Guz-Lavi.
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