In place of the big bucks that larger corporations can offer employees, early-stage startups typically offer equity — a way to incentivise employees of young businesses by giving workers a direct stake in the success of the company. (Sifted has a handy guide explaining how startup equity works.)
But the startup world in 2022 has been shaken up by several waves of layoffs, with some of the biggest names in the business, like Klarna, Gorillas and Cazoo, cutting their headcounts after being hit by trying economic conditions.
So if you’re laid off, what do you need to know about your equity?
What portion of your share options are vested?
Most startups offer share options — which give you the option to buy the equivalent equity at a fixed price (known at the “strike price”) further down the line — in a vesting schedule, meaning you earn the right to more shares the longer you stay at the company. Four-year vesting schedules are most common, where employees gain the right to 25% of their options each year for four years.
The 12-month mark is known as “the cliff”, because once you’ve crossed it options start to aggregate day by day but, up until that point, you don’t have any vested options.
So, if you leave on day 364 of your first year at a company you would leave with no share options, but if you leave on day 366, you’d typically leave with 25%. Some companies have brought the cliff forward for people who were laid off before they reached it — more on that below.
Aside from the four-year schedule, there are other models too, and more and more European startups are experimenting with them.
One is the “back-loaded vesting” schedule, where options vest by 10% in the first year, then 20%, 30% and 40% across the next three years. Companies like Amazon and Snap use the system, which some say can improve employee retention, because people need to stay on longer to gain access to the bulk of their options.
Will your company remove the cliff?
In the recent layoffs spree in Europe, some companies removed the cliff for employees who were let go before their shares vested.
Speedy grocery company Zapp is one of them. It laid off 10% of its employees earlier this year, but an internal email clarified that any employees who left before their equity cliff period ended would retain their vested shares.
So if someone worked at Zapp for eleven months, they’d get 23% of their options — nearly all of the 25% they’d receive if they stayed for twelve months. Typically, the cliff means you get no options at all until the year mark, where you get 25%.
Are you a good or a bad leaver?
Robin Hartley, lawyer at Doyle Clayton specialised in stock options contracts, says there are a number of formal contracts that laid off employees ought to check.
In most contracts there will be a section that defines what a “good and a bad leaver” is.
“In the good leaver section, it often says that someone who's been made redundant is a good lever,” Hartley says. “But I would say about 60% of companies just have everyone as a bad leaver” — where people who choose to leave and those who are laid off are treated the same in terms of options.
If you find laid off employees are classed as bad leavers, you have little chance of being able to exercise your options — unless you can negotiate that as part of your redundancy package.
About 60% of companies just have everyone as a bad leaver
“There's no hard and fast rule. It's a matter of looking at that good leaver clause in the options agreement,” Hartley says.
In the UK, if laid off employees are classed as good leavers, they then need to check the same rules are laid out in their employers’ legal documents in Companies House.
There’s a document called the Articles of Association, which will again label laid off employees as either good or bad leavers. It’s important to check both that document and your contract, Hartley says, because the two can sometimes contradict each other.
If you’re classed as a bad leaver in one and a good in the other, the bad tends to overrule the good, Hartley says.
If you’re classed as a bad leaver, can you negotiate something better?
If your contract determines you to be a bad leaver, there might be room to negotiate as part of a redundancy settlement.
“You may be in line for some sort of redundancy payment,” says Hartley. “If the company is cash-strapped, there may be some negotiation to say you'll give up some or all of that payment in return for keeping some of your shares.”
Hartley says he's seen a few employees manage to negotiate this as part of redundancy packages. If an agreement can be reached, however, Hartley warns that employees should be careful to get it in writing and spell out clearly things like how long they will hold the options for.
If you can, should you exercise your options?
Those who are classed as good leavers can then exercise their options — which means purchasing them at the strike price and turning them into shares. If you joined a company early, the strike price may be very low, but exercising options can still be expensive.
In some European countries, like Germany, strike prices are based on a startup’s latest fundraising valuation. In the UK, employers can offer a reduced strike price without receiving a tax penalty, by obtaining a “fair market valuation” — an estimated valuation of the company — which is recognised by tax authorities.
“You have to work out how much you need to pay to exercise your options, and then work out whether you think it's a good deal to exercise your options right now… [but] it may be that it's too expensive,” Hartley says.
Deciding whether to exercise options will be an individual decision on the person's finances at the point they are laid off, and an assessment of the company’s prospects, to determine whether the value of the shares is likely to increase enough to make exercising the options worthwhile.
It’s also a question of tax. People who exercise their options can be asked to pay a high tax bill on them before the shares are liquid, which means it can be a long time before people see the rewards.
How long after you leave do you have to exercise your options?
In the US, where the four-year vesting schedule was popularised, employees who leave a role typically have 90 days within which to exercise vested options.
In Europe, things are a little bit different. In continental Europe, only 50% of companies ask employees to exercise their options in the 90 days following their exit from the company, according to data from Index Ventures.
At 44% of companies in continental Europe, employees retain their rights but cannot exercise them until the company exits. It’s similar in the UK: 62% of companies give employees 90 days, and 29% give employees the retained right to options, but they cannot exercise them until an exit. The remaining percentage of UK companies dissolve employees’ rights to options if they leave early.
Know your rights in your next role
What’s critical for laid off employees is that they go into their next role with a full understanding of how the stock options system works at that new company. From day one, make sure you understand the nature of your relationship with the new company and how your ownership structure works.
