Equity Without the Clock: How Startups Are Rewriting Stock Option Rules with Extended Post-Termination Exercise Periods

Employee stock options (ESOPs) are often pitched as a golden ticket to share in the success of a company you helped build. ESOPs promise financial freedom, wealth creation, and alignment with long-term business goals.

But here's the catch: for many employees, these promises remain just that. The upside never materializes.

Not because the company fails, but because they run out of time. Most employees have only 90 days to exercise their options after leaving, due to a short Post-Termination Exercise Period (PTEP).

In this post, we explore why the 90-day rule exists, how it is changing, and what both founders and employees should know about extended PTEPs.

What is the Post-Termination Exercise Period (PTEP) ?

The Post-Termination Exercise Period (PTEP) is the time an employee has to exercise their vested stock options after leaving a company. If they don’t act within this period, the options expire and return to the company’s ESOP pool.

Currently for Incentive Stock Options (ISOs), the U.S. tax code requires that employees exercise their options within 90 days of leaving the company in order to retain favorable tax treatment. This 90-day rule does not apply to Non-Qualified Stock Options (NSOs). Companies have more flexibility to set longer exercise windows for NSOs.

But to keep things simple, many startups apply the same 90-day limit across both ISOs and NSOs. 

A challenging position: When time really is money

For employees, the biggest challenge isn’t just earning stock options. It’s being able to exercise them before time runs out.

The standard PTEP is typically limited to 90 days, which often isn't enough time for employees to:

• Arrange the capital to pay the exercise (strike) price
• Prepare for potential tax liabilities

If an employee is unable to manage the financial requirements within the short window, they risk forfeiting all vested options. These unexercised ISOs are then returned to the company’s option pool and may be reissued to new hires.

This leads to a significant loss of potential value for employees. It also undermines the goal of equity compensation.

This “use it or lose it” dynamic creates financial burden on employees.

What U.S. tax law says about the 90-day Post-Termination Exercise Period (PTEP)

The 90-day exercise window originates from Section 422 of the Internal Revenue Code. 

According to the IRS, an ISO must be exercised within three months of the employee’s termination to retain its tax-advantaged status.

Here’s what the IRS says:

“At all times during the period beginning on the date of the granting of the option and ending on the day 3 months before the date of such exercise, such individual was an employee of either the corporation granting such option, a parent or subsidiary corporation of such corporation, or a corporation or a parent or subsidiary corporation of such corporation issuing or assuming a stock option.”

If exercised within the 90-day window, ISOs are not taxed at the time of exercise unless subject to Alternative Minimum Tax (AMT). 

If exercised after the window, the options are reclassified as NSOs, and the spread between the exercise price and the fair market value (FMV) becomes taxable as ordinary income during exercise.

For most companies, this 90-day PTEP has become a standard template for all equity grants, even when flexibility exists, especially for NSOs.

Extending the Post-Termination Exercise Period (PTEP)

Startups are increasingly revisiting the 90-day PTEP model and offering extended post-termination exercise periods.

An extended PTEP can range from one year to as much as ten years from the date of grant (maximum allowable term under Section 422 of the Internal Revenue Code for ISOs), depending on company policy and whether the options are ISOs or NSOs.

Benefits of extended PTEP for employees

1. Adequate time to arrange funds and plan taxes: Employees are better positioned to manage liquidity and tax planning.

2. Reduced risk of forfeiture: More time increases the likelihood that employees will exercise their options.

3. Improved financial outcomes: A longer exercise window gives employees time to wait for a liquidity event or company growth, potentially increasing the value of their options when they choose to exercise.

Benefits of extended PTEP for companies

1. Retention and employer branding: Startups with extended PTEPs stand out in competitive hiring markets.

2. Fairness and goodwill: Recognizing the effort of former employees contributes to long-term goodwill and alumni advocacy.

3. No restrictive exit clause: A longer PTEP allows employees to explore new opportunities without the financial pressure of an immediate exercise decision. In contrast, a short window may force them to stay in a role just to save their vested options, leading to disengaged employees who remain only for a potential payout rather than meaningful contribution.

Statutory compliances for extended Post-Termination Exercise Periods (PTEPs)

Extending the PTEP is not just an internal policy change. It involves important legal and tax implications, especially under U.S. law.

For companies, the key considerations include:

1. Reclassification of ISOs to NSOs: Extending the exercise window beyond 90 days for ISOs results in automatic reclassification to NSOs, as required by IRS rules. This changes how the options are taxed — any spread between the strike price and fair market value becomes taxable as ordinary income at the time of exercise. 

‍2. Potential violations of Section 409A: NSOs are subject to Section 409A of the Internal Revenue Code, which sets rules for deferred compensation. If an NSO extension or modification doesn’t comply with these rules, employees may be hit with immediate income taxes, additional penalties, and interest charges, even before exercising the options.

‍3. Plan disqualification: Extending PTEPs beyond 90 days effectively converts ISOs into NSOs. If a company chooses this approach, it must ensure the stock option plan is explicitly updated to reflect this shift. Failure to do so can create confusion around the plan’s status and risk disqualification for other ISO grants that were intended to have the 90-day PTEP.

‍4. Employee disputes: Lack of clarity or poor communication about exercise timelines and tax treatment can lead to misunderstandings or legal claims from former employees.

To avoid these risks, companies need to do the following:

• Review and update the stock option plan to ensure it supports longer PTEPs.
  
• Ensure necessary approvals and proper documentation are in place prior to adoption of any such extension.
• Compliances of the IRC regulations including Section 409A with respect to such extension along with the contractual obligations.
• Consult legal and tax advisors to confirm compliance with IRS regulations.
  

In short, while extended PTEPs can be a valuable benefit for employees, they must be implemented with care.

Conclusion

A growing number of tech companies have recognized the challenges employees face with short exercise windows and are taking action.

For example, Pinterest adopted a policy that gives former employees up to seven years to exercise their vested options after leaving the company.

Extending the post-termination exercise period isn’t just a perk, it’s a strategic decision that supports employee well-being while aligning with long-term company goals. With the right legal and tax guidance, extended PTEPs can turn the promise of equity into lasting value for both employees and the business.