PTEP Extensions in Private Company Stock Options

Post-Term Exercise Period Extensions for Private Company Options

In many companies, the startup phase ends with significant growth in stock price, leaving older options deep in the money. However, if an IPO is still several years away, employees can run into liquidity challenges. They may stay with the company simply because they don’t have the capital to cover the exercise price and the related tax burden.

One solution to this issue is to extend the post-termination exercise period (PTEP). This allows employees who leave the company to keep their vested options until a liquidity event occurs, making it easier—and potentially more profitable—for them to exit.

That said, extending the PTEP comes with challenges. It can lead to increased accounting expense, changes in valuation methodology, and different tax treatment. While a full review of liquidity strategies is beyond the scope of this discussion, the following outlines key considerations for companies evaluating this approach.

Accounting Implications of Extended PTEPs

Typically, PTEP extensions apply only to vested but unexercised options, which triggers a Type I modification under ASC 718. Any incremental fair value resulting from the extension must be recognized immediately for the affected shares.

In simple cases, this can be handled with offline calculations. However, things become more complicated when PTEP extensions are applied regularly across employees, grant dates, and vesting tranches. Each modification is a separate event with its own assumptions.

Without a structured way to document and track these changes, the workload can quickly become difficult to manage. Keeping valuation methods, assumptions, and award-level details in a centralized location from the start helps ensure a smooth audit process and avoids last-minute issues.

Valuation Implications of Extended PTEPs

Extended PTEPs have a meaningful impact on how stock options should be valued. Many private companies rely on the Black-Scholes-Merton (BSM) model to value at-the-money, plain-vanilla options at grant. However, changes in post-termination exercise behavior make some of its assumptions less reliable and increase the relevance of lattice-based models.

Why the Black-Scholes-Merton Model Works for Standard Options

At a high level, the BSM model simplifies things by combining all employee exercise behavior—such as voluntary exercise, forfeiture, and termination—into a single input: the expected term. This input is typically applied across all employees.

Where Extended PTEPs Create Valuation Challenges

ASC 718 requires that any valuation method reflect all key features of the award. Extending the PTEP changes one of those features in an important way: how and when employees are likely to exercise their options.

With a standard 90-day PTEP, employees who leave the company must quickly decide whether to exercise or forfeit. There is very little time value remaining, so the decision is mostly driven by intrinsic value, along with the challenge of selling shares in a private market. In these cases, options are typically considered “plain vanilla,” and SAB 110 allows the use of a simplified midpoint-based expected term in a BSM framework.

When the PTEP is extended to several years, the situation changes. The option holder is no longer behaving like an employee but more like a financial investor. Their decisions are driven by investment considerations rather than retention or immediate liquidity needs. For example, someone with a five-year window has little incentive to exercise early if there is no market to sell the shares.

In this scenario, BSM doesn’t fully capture the behavior of the option holder, and the shortcut method is no longer appropriate.

The Lattice Model Alternative

A lattice model builds a price tree over time and allows for different exercise behaviors at each stage. For example, it can model early exercise when the stock price reaches a certain multiple of the strike price or reflect different behavior after termination.

This approach allows companies to model post-termination holders more realistically, capturing how their incentives differ from active employees. It also reflects the fact that exercise is more likely when there is meaningful stock price growth and potential liquidity.

The table below shows how BSM can fall short. Using assumptions of 60% volatility, a 4% risk-free rate, and 0% dividend yield, we compare BSM and lattice values across options with different levels of moneyness (S/K) and remaining terms. Values are shown as a percentage of the current stock price.

Our sample lattice model assumes exercise when the stock price reaches 2.5 times the strike price. For BSM, the expected term is estimated based on time elapsed and moneyness. While this is a reasonable approximation, it still leaves noticeable differences in value.

At grant, for an at-the-money option with a 10-year term, both models produce similar results. This aligns with the research supporting BSM’s general use. However, as time passes and moneyness changes, the gap between the two models increases.

In out-of-the-money scenarios with shorter remaining terms, differences can reach up to 25%. These are exactly the situations where extended PTEPs are most relevant, and where lattice models provide a more accurate reflection of expected behavior.

Tax Implications for Incentive Stock Options (ISOs)

Extending a PTEP beyond the standard 90-day window removes the favorable tax treatment associated with incentive stock options (ISOs) for exercises that occur after that period.

What this means in practice is that employees lose eligibility for long-term capital gains treatment. Instead, they must recognize ordinary income on the spread at exercise, similar to a nonqualified stock option.

This can be an unexpected outcome if it is not clearly communicated, so companies should make sure employees understand the tax impact before making any decisions.

In Closing

Extended post-termination exercise periods can provide meaningful flexibility for employees, but they also introduce important considerations across accounting, valuation, and tax. Companies evaluating this approach should carefully assess the impact of ASC 718 modifications, ensure their valuation methodology reflects changes in exercise behavior, and clearly communicate potential tax consequences to employees to avoid unintended outcomes.

For more resources, visit the Private Company Stock Plans section on NASPP.com