Employees Running Low on Options

Aside from the hybrid roles and flexible work environment you might find, there’s a key perk that attracts many top talents to early stage start-ups: stock options.

While startups aren’t able to offer top talent the same salary or benefit packages that a larger tech player might, they are able to offer larger, more promising equity packages. If the company ends up having a successful exit or entry into the public markets in the future, these options packages can be extremely lucrative… if they are exercised.

While one would think that employees would be taking advantage of the ownership opportunity, Carta’s most recent State of the Private Markets implies otherwise. As the infographic below shows, in 2023 employees exercised a record low 26% of vested options.

What is causing this decline in option exercising? The answer appears to be two fold. First, valuations have been declining across all stages of VC-backed companies, with late stage being the most impacted by these declines. For employees who joined startups in 2020 and 2021, there is a high likelihood that their option packages might be underwater now. This means that the strike price on the options is greater than the current Fair Market Value of the stock. For example, you may have options with an exercise price of $20 a share, while the stock is only valued at $14 a share. In this situation, you are effectively having to overpay for the company stock.

Exercise rates may also be low right now too due to bearishness surrounding exit prospects for startups. The current economic environment has been plagued by a lack of exits and IPOs, as well as ongoing news about the difficulties of raising capital and startups failing. With option exercise sometimes requiring a considerable amount of capital commitment, employees might be weary tying so much money up in an illiquid asset with high risk levels.

Wait, but why were exercise rates below 50% even in 2021 when VC was booming? Some of the answer to that question might be in line with the point above about the capital commitment required for exercising. In their 2022 Employee Stock Options Report, Carta ran a survey for why employees are not exercising their options. The results were extremely interesting. Employees reported they didn’t exercise options in the past because they:

• Couldn’t afford the cost to exercise or associated taxes (23%)
• Thought it was too much of a financial risk (18%)
• Were worried about making a mistake or thought they already owned them (13%)
• Didn’t think their options were worth anything (11%)

While cost and financial worries made up about 41% of employee rationale, 13% did not exercise because they lacked education.

Why this matters: Employees are leaving an extremely high number of options on the table right now. Based on historical figures, they have never exercised at a rate above 50%. These packages can be extremely fruitful if the company performs well, and employees that fail to educate themselves on the value of their option packages may miss out on a significant return in the future. Education on option exercise, as well as solutions for exercising with less personal financial risk, will help employees to make informed decisions about how to take advantage of their entire compensation packages at their company.

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