Pinterest Made a Deal With Employees That Could Rock the Startup World

The change could be a boon to startup employees if other big private companies follow suit.

By Maya Kosoff • Mar 25, 2015

This story originally appeared on Business Insider

Last week, Pinterest made a huge change that will allow its employees to collect equity on terms more favorable to them, Fortune's Dan Primack reports.

The digital pinboard company will let employees who leave after at least two years of service retain their vested stock options for an additional seven years without exercising them.

This is rare for startups and could be a huge boon to startup employees if other big private companies follow suit.

Here's why:

Typically, startup employees give up higher salaries in favor of taking stock options.

The hope here is that when the startup they work for becomes super successful, those stock options will be worth more than their lost salary, and the employees will cash in on their company's success as it grows.

But there's a catch: Employees who leave companies are usually given 90 days to exercise those options. That means the employee has to buy the options at the "strike price" — the stock price at the time when the options were granted.

The employee may also have to pay taxes on the value of the exercised options. (This gets confusing, as there are different kinds of options, and some of those taxes can sometimes be refunded in later years — read up on the Alternative Minimum Tax and incentive stock options if you're interested in the details.)

If the company is public, this isn't a huge problem. The employee can just sell some newly exercised shares at the market price — which is presumably higher than the strike price (or the shares aren't worth exercising) — then take that money and use it to buy the rest of the shares and pay taxes.

So, for instance, an employee who is granted 10,000 shares might be able to sell 1,000 to pay for exercising those shares and 500 for the tax bill and still end up with a nice 8,500 shares.

But what if the company is still private, as is increasingly the case with the hottest tech companies?

Then, unless the company is willing to buy back those shares or willing to let the employee sell them on the secondary market, the employee has to pay cash, up front, to exercise those shares. Then the employee has to pay more to the IRS.

Companies usually give employees a short window to exercise, something like 60 or 90 days. If you're too cash-strapped to buy those shares and pay taxes during that window, too bad. No stock for you, no matter how long you were at the company and how many options you were granted.

Pinterest is giving employees a much longer time — seven years — to come up with the money to buy unexercised options.

That effectively makes those options a lot more valuable as compensation, as nearly every employee will be able to exercise them — especially if the company goes public during that time, and employees can sell some shares to cover the cost of exercising them.

If other companies follow suit, this could change the entire landscape for startups, making it easier for them to attract and retain employees.

Just last week, Pinterest raised an additional $367 million at an $11 billion valuation. In total, Pinterest has raised $1.1 billion.

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