1

What happens to employee stock options and stocks in those rare cases where a start-up is wildly profitable -- but the founders never "exit"? That is, it never goes public or is acquired.

Controlling stock-holders (i.e., not employees) have an incentive to exit, but they can just pay themselves dividends instead, keeping the company private and never exiting.

Could someone clarify why this is not a real possibility -- or is it?

Improve this question
14
  • Does this answer your question? Employee stock option plan with undefined vesting?
    – Grade 'Eh' Bacon
    Dec 20, 2022 at 15:01
  • 1
    The linked question answers what might be the main thrust of your question [in short - if you don't see very clearly laid out in contract form where you would gain the right to exercise your option, they could easily be worth almost nothing], but I'm not sure if there's more going on in your question, which goes in a few directions.
    – Grade 'Eh' Bacon
    Dec 20, 2022 at 15:02
  • 1
    Well, you could vote the stock, and try to promote a shareholder motion that the company pay dividends or buy back these shares... But I think the answer winds up being that if you chose to exercise the option before knowing you could sell the shares you've defeated the purpose of having options rather than shares in the first place.
    – keshlam
    Dec 20, 2022 at 16:25
  • 2
    @JoshuaFox Are you actually trying to find an answer to a question, or are you just ranting about poor business practice? Yes, it is incredibly true that many employees hold options or stock that will never reach the point of being converted to cash. Contract and corporate governance law provides some amount of protection in cases where such minority shareholders might be getting poorly treated, but you can only enforce the law through the legal system - ie: by suing the company. Therefore, for tiny fractional ownership amounts, it may never be worthwhile to fight for a few hundred dollars.
    – Grade 'Eh' Bacon
    Dec 20, 2022 at 17:25
  • 1
    @JoshuaFox corporate law [as evidenced through a lawsuit] comes into play if the majority owners ever do anything that restricts your value in the hypothetical 'trillion dollar company]. Poor business practice would be having minority shareholder interests who hate your guts because you don't provide them reasonable avenues to liquidate - this is incredibly uncommon. Usually liquidation is limited on the basis of unprofitability and lack of interested buyers. once again I will add - all of this is hypothetical without an actual contract for the options + future shares in hand.
    – Grade 'Eh' Bacon
    Dec 20, 2022 at 21:33

3 Answers 3

Reset to default
2

If this is your concern, the trivial way to protect yourself is not to exercise the option until you know that you can sell it. Which is, in fact, what most folks do.

If you decide to (and are able to) exercise it early, I would hope you have some overriding reason to do so -- dividends, participation at shareholder meetings and voting the share(s), whatever. If you did it by mistake... well, you still get to live with the consequences of the decision. Not worthless -- it's still partial ownership of the company, entitled to dividends if any and a proportionate vote -- but not tradable on the open market so not easily cashed out.

This sounds like a pure hypothetical, though. The number of people who would try to exercise an option prematurely is vanishingly small. As I said in comments, doing so defeats most of the purpose of of having an option in the first place.

Improve this answer
7
  • Thank you. Let's say that an employee does not exercise the option, as you say, and that (in the specific and exceptional case that I am raising) the company becomes extremely valuable, yet remains private with no exit. So, the employee has extremely "valuable" options that remain worthless, possibly for many decades. Is that correct?
    – Joshua Fox
    Dec 21, 2022 at 7:52
  • 2
    Not worthless -- it's still partial ownership of the company, entitled to dividends if any and a proportionate vote -- but not tradable on the open market so not easily cashed out.
    – keshlam
    Dec 21, 2022 at 10:57
  • Thank you @keshlam. That does seem to be the right answer, or at least no one else provided a better one yet. It does seem like the scenario that I described is indeed possible. Could you write that answer up?
    – Joshua Fox
    Dec 21, 2022 at 15:03
  • Edited additional comment into my answer.
    – keshlam
    Dec 21, 2022 at 15:11
  • 1
    @JoshuaFox "I would omit 'not to exercise the option'" - I think you may be overestimating your understanding of the subject matter. The point of that comment is to reflect the fact that exercising the options typically costs money - something you shouldn't do, if you have no foreseeable way to get value from doing so. in 99% of cases, employee granted stock options shouldn't be exercised until the moment the employee has a plan to sell the shares being received. This saves cashflow and may defer some tax consequences until as late as necessary. This is why your scenario is so unlikely.
    – Grade 'Eh' Bacon
    Dec 21, 2022 at 17:51
1

They're valuable. You can exercise them and join the ranks of shareholders. This way, when the company is sold or distributes dividends you'll get some money too.

However to exercise the options you may need to put some money first. You'll need to pay the "option" price: the price at which you were given the option to purchase the shares.

It may also be taxed (depending if it is ISO or NSO and length of holding periods) because there may be a difference between your option price and the fair market value of the shares at the time (that's the benefit).

Whether to invest or not - is up to you. This may be an opportunity to invest in a private and (as you say) wildly profitable business, or may be a huge waste of money. With private companies you have very little visibility into the company's financials and actual business results may not be as glowing as you think.

Improve this answer
5
  • "you can exercise them"--I am referring to exercised options. "When the company is sold or distributes dividends" -- thank you, that is what I am asking about. What if it is never sold? In that case, one cannot sell them (in the case of the typical ESOP). But I appreciate your point about getting dividends.
    – Joshua Fox
    Dec 20, 2022 at 18:56
  • 4
    @JoshuaFox "excerised options" are called shares. You can potentially sell shares you've purchased in ESOP as OTC shares or in private transactions, though it may not be as easy as a click of a button.
    – littleadv
    Dec 20, 2022 at 19:03
  • thank you. Correct, OTC and private transactions are possible, and as you say it can be difficult. It is quite commonly barred by industry-typical ESOPs. So does that mean that employee may have options or shares in a wildly valuable company that in fact are, to him, worthless?
    – Joshua Fox
    Dec 21, 2022 at 7:53
  • @JoshuaFox I think you'll find that "industry standard" ESOP's will outline the value proposition of ownership - both receipt of dividends as well as requirements that must be met to sell [often limited to other employees, or back to the company, and possibly limited to when you quit]. You are asking about "is it possible for an ESOP to be so poorly constructed that any employee foolish enough to exercise their options will be stuck with worthless shares?" - and the answer is, not under corp law protecting minority shareholders, but for negligible share values compensation could be arduous.
    – Grade 'Eh' Bacon
    Dec 21, 2022 at 17:58
  • 1
    @JoshuaFox you can always sell your shares, these are your assets. The only restrictions ESOPs impose are related to who you can sell it to in a private sale, or holding period after an IPO. In a private sale, many ESOPs have a condition that the company has the right of first refusal. But I've yet to see any ESOP that provides absolutely no liquidity. "Not click of a button" doesn't necessarily make a private sale difficult though, there are OTC brokers, facilitators, and people very much interested in buying who can help you sell.
    – littleadv
    Dec 21, 2022 at 19:07
-1

Generally speaking, it is illegal for a majority shareholder to extract value from a company, to the detriment of minority shareholders. Whether you are able to get compensation for such an action would depend on your ability to access legal justice [can you afford to hire a lawyer to sue for what might be a few hundred dollars of payout?].

First, I'll quickly point out that before shares in a company are even worth anything, it must do extraordinarily well - like the top 1% growth potential of the top 5% profitable of the top 50%-or-so that don't fail in the first year - which is so unlikely that in most cases, employee stock options are near-worthless for new startups.

The options being granted should have some contract terms included, guiding when and how they can be exercised in exchange for shares. Those shares also should have some provisions indicating how and when they can be sold. If you don't know these things in advance, assume the worst - that you have no special protections not already provided by your jurisdiction's corporate governance law.

Lack of clarity over how you can convert these options / shares into cash is a bad sign - likely implying poor financial / legal practices on behalf of the company, as well as perhaps implying an unrealistic approach to how the owners might think things will go. ie: if an owner of a startup offers stock options on the assumption that eventually the company will go public, and that s/he doesn't need to worry about conversion in the meantime, that means they are planning only for the unlikeliest-best-case scenario, and not concerned with compensating you if the company is only in the 98th percentile of startups instead of the 99th+ percentile.

Improve this answer
7
  • For purposes of this question, I am discussing here only the exceptional cases where a startup achieves extreme value. "If the rights you hold do not properly define how they may be ... sold" -- standard ESOPs ban selling before an exit, without permission. So, this is quite normal. If we are saying that in such cases, with an industry-standard ESOP and a wildly profitable and valuable company, employees still hold worthless stock, then OK. But it does seem surprising.
    – Joshua Fox
    Dec 20, 2022 at 16:25
  • "to extract value from a company, to the detriment of minority shareholders." OK. But if the company simply continues to operate as a private company, that is not to the detriment of minority shareholders (employees).
    – Joshua Fox
    Dec 20, 2022 at 16:25
  • @JoshuaFox Even private companies are held to the legal requirements of contract law and corporate governance law. If you have a contract outlining when / how you can exercise your options + how you could later sell those shares, then the company would at bare minimum be legally held to following through on those provisions. Beyond that, a majority shareholder cannot [for example] pay dividends out prior to company bankruptcy thus neglecting minority shareholders. Of course, as with every legal matter, what is 'legal' only matters in a courtroom. Proving misconduct may be arduous.
    – Grade 'Eh' Bacon
    Dec 20, 2022 at 17:16
  • Even options holders likely have some rights available to them, but those rights probably don't extend to "pay me now", more like "follow through on the options contract terms and don't bankrupt yourself purposefully for personal enrichment in the meantime". In many cases, employee options might constitute tiny fractional percentages of ownership, and as a result, their value, even if realized in open market selling, could be tiny, especially relative to legal costs. This is why options / equity in tiny startups often ends up worthless, and shouldn't be over-considered by employees.
    – Grade 'Eh' Bacon
    Dec 20, 2022 at 17:18
  • "Even options holders likely have some rights available to them". Indeed. I am actually referring to stock-holders here (and specifically in the context of companies that become valuable). These stock-holding employees, and they have stock-holder rights -- but not (with an industry-typical ESOP) the right to sell, in the case of a company that remains private.
    – Joshua Fox
    Dec 20, 2022 at 19:00

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .