Decline in Exercising Vested Startup Stock
Carta’s H2 2024 State of Startup Compensation Report (here) highlights a key trend that startup founders, CEOs, and CFOs should be aware of: Employees are increasingly hesitant to exercise their vested stock options. In Q4, only 32.2% of vested, in-the-money options were exercised, a significant drop from 54.2% three years ago. Exercise rates continue to hover near recent lows.
There are seven factors contributing to this trend:
Liquidity Concerns – Many startups are staying private longer, delaying potential exit opportunities like IPOs or acquisitions. This makes it harder for employees to sell their shares and realize gains.
High Exercise Costs – Exercising stock options often requires a significant upfront cash investment, especially for late-stage startups with higher valuations.
Tax Implications – Exercising options can trigger immediate tax liabilities, particularly if the stock’s fair market value has increased. Many employees may be unable or unwilling to pay these taxes without a clear path to liquidity.
Market Uncertainty – Economic volatility and fluctuating startup valuations make employees cautious about investing in company stock, especially if they perceive the risk of a down round or a decline in company value.
Layoff Fears & Job Mobility – Employees concerned about job security or considering switching companies may prefer to hold off on exercising, especially if they’re unsure about the long-term prospects of the company.
Lack of Financial Education – Consistently across startups its observed that many employees do not fully understand the mechanics and risks associated with stock options, leading them to delay or avoid exercising.
Shift in Compensation Preferences – With increased awareness of the risks of startup equity, employees may prioritize cash compensation over stock options, particularly in a high-interest rate environment where alternative investment options may seem more attractive.
Encouraging employees to exercise their stock options benefits both the company and employees by fostering alignment, engagement, and financial stability. When employees have a financial stake in the company, they are more motivated to contribute to its success, leading to higher retention and a stronger company culture. A higher exercise rate also improves liquidity planning, allowing startups to better manage tender offers and secondary sales while reducing overhanging liabilities and potential dilution. Additionally, a history of exercised options enhances the company’s attractiveness to future talent and helps refine equity compensation strategies to remain competitive.
By implementing strategies such as liquidity programs, tax education, alternative financing options, and extended exercise windows, startups can better support employees in exercising their stock options. This not only maximizes the impact of equity compensation but also fosters a culture of shared success and long-term commitment.
Conclusion
The declining trend in employees exercising their vested stock options highlights a growing challenge for startups in balancing equity-based compensation with financial realities. Liquidity concerns, high exercise costs, tax burdens, and market uncertainty are key deterrents, compounded by a lack of financial education and shifting compensation preferences. To address this, startups must proactively improve liquidity options, reduce financial barriers, educate employees on stock options, and optimize equity structures. By doing so, they can enhance employee participation in equity programs and maintain the appeal of stock-based incentives in an evolving market landscape.