Vested Equity and Employee Exits at Private Companies

When an employee leaves a private company, one of the most pressing questions is for equity plan administrators:

What happens to their vested equity?

It’s a deceptively simple question, but one of the thorniest challenges private companies face as they scale. In early-stage startups, the issue may not even arise, since most employees are focused on growth and liquidity is far off. But as companies mature, turnover increases, liquidity events draw closer, and the stakes get higher. Suddenly, deciding how to treat vested equity at termination can become a board governance debate.

Should you always repurchase? Only sometimes? Never?

The answer matters because it influences employee retention, morale, investor confidence, and the long-term health of your cap table management strategy. In this blog, we’ll examine why private companies adopt different approaches, what factors drive those decisions, and how you can design a repurchase policy that works for your organization.

Why Repurchase Vested Equity at Termination

Equity isn’t just a line item in compensation — it’s ownership. And ownership carries meaning well beyond the paycheck.

The way you handle vested equity at termination tells a story about your company’s values and how you treat employees. It signals whether equity is primarily a reward for past service, an incentive for future contributions, or a mix of both.

Handled poorly, an unclear equity compensation policy can:

• Weaken retention: If employees believe they’ll be paid out regardless of performance, equity loses power as a motivator to stay.
• Create “free riders”: Former employees benefit from future growth without contributing, frustrating current employees.
• Dilute shareholder returns: Value intended for active contributors is shared with people who’ve moved on.
• Undermine board confidence: Failing to repurchase at fair market value can be interpreted as doubt about the company’s trajectory.

Handled well, the policy can:

• Reinforce alignment: Equity remains tied to contribution and performance.
• Protect the cap table: Reducing inactive holders keeps governance clean.
• Build trust: Clear, consistent treatment signals fairness to both employees and investors.
• Preserve flexibility: Repurchase rights, when structured carefully, give the company financial and strategic options.

This is why companies wrestle with the question — and why there’s no single “right” answer.

The Four Common Approaches to Vested Equity in Private Companies

When it comes to repurchase rights, companies typically adopt one of four models:

1. Never Repurchase

The company lets employees keep vested equity.

• Pros: Simple; avoids immediate cash outlays; provides a generous benefit that can support employer branding.
• Cons: Leaves “alumni” on the cap table; dilutes active participants; misaligns ownership with contribution.

2. Repurchase at FMV by Default

In this approach, vested equity is repurchased at fair market value when the employee leaves, usually determined by a 409A valuation or other appraisal.

• Pros: Keeps the cap table clean; ensures only active contributors participate in future growth; provides liquidity to the departing employee.
• Cons: Can be expensive, especially during periods of high turnover or rapid valuation growth. May spark morale issues if underperformers receive large payouts.

Example: A SaaS company with 300 employees sets a default rule: all vested options are repurchased at FMV upon termination, unless the board approves otherwise. The policy keeps their investor group happy but requires careful cash-flow planning.

3. Repurchase at a Discount

Here, the company buys back vested equity at a value lower than FMV — perhaps book value, a fixed formula, or a percentage discount.

• Pros: Reduces cost burden; discourages “free riders.”
• Cons: Can be perceived as unfair or punitive. May harm the company’s reputation with future recruits if word spreads.

Example: A consumer brand applies an 80% FMV rule. Employees still receive value, but not the full upside. They frame this as sharing in “value already built” while protecting the majority of future value for current employees.

4. Case-by-Case Discretion

Decisions are made individually, often requiring board or executive approval.

• Pros: Offers maximum flexibility. Companies can weigh individual circumstances, performance, and cash flow.
• Cons: Inconsistent application risks perceptions of favoritism. Lack of clarity can cause uncertainty among employees.

Example: A biotech startup repurchases in most cases but allows board approval exceptions for long-tenured employees or unique situations like retirement.

Key Considerations in Shaping Private Company Repurchase Policy

Which approach makes sense for your company? Here are the factors to weigh:

1. Equity Type

Not all equity is created equal, and the structure of the instrument itself often dictates how you should think about repurchase rights.

When shaping policy, start by mapping out which equity vehicles are in play. A strict repurchase rule may be essential for options but less necessary for RSUs. The more varied your equity mix, the more important it becomes to align your approach with both the economics of the instrument and the philosophy of your ownership strategy.

Treatment of Vested but Unexercised Options

One question that often arises is what happens to vested but unexercised stock options when an employee departs. Do they lose the right entirely, or should they be allowed a window to exercise?

Some companies allow departing employees to exercise vested options and then immediately sell the resulting shares back to the company, creating a cash obligation for the company. Others cancel unexercised vested options at termination.

Canceling immediately may feel unfair, since the employee could have exercised and then participated in the repurchase if they’d acted before giving notice. On the other hand, allowing a post-termination exercise-and-sell arrangement can significantly increase the company’s liquidity burden at the worst possible time.

A balanced approach is to:

• Provide a defined post-termination exercise window (e.g., 30–90 days) for vested options.
• Clarify whether the company has the right or obligation to repurchase any resulting shares.
• Communicate these rules clearly in plan documents and exit materials, so employees understand their choices before they leave.

This ensures fairness while keeping the company’s cash exposure predictable and manageable.

2. Cash Flow

Does the company have the liquidity to fund repurchases? A policy that looks good on paper may fail in practice if the company can’t afford large payouts.

3. Ownership Philosophy

Do you view equity as strictly a retention tool? Or as a broader wealth-sharing mechanism for anyone who contributed to value creation, regardless of tenure?

4. Signal to the Market

Repurchasing at FMV signals confidence in continued growth. Declining to repurchase may be read by investors as hesitation about future value.

5. Board and Leadership Views

Ultimately, boards care about dilution, governance, and signaling. If your leadership team believes strongly in maintaining a clean, performance-aligned cap table, repurchase will be the preferred route.

The “Free Rider” Problem

Perhaps the strongest argument for repurchase rights is the elimination of “free riders.”

Imagine two employees: one stays, one leaves. Both hold vested equity. The company doubles in value. The departing employee benefits just as much as the one still working — without lifting a finger.

For boards and active employees, this can feel unfair. Why should someone no longer contributing share equally in the upside?

This issue is magnified in growth-stage companies, where future gains can be dramatic. If unchecked, free riders can:

• Dilute active participants’ value
• Create resentment among current employees
• Complicate future fundraising or exit negotiations

The Retention vs. Morale Tradeoff

Equity is designed to motivate employees to stay. If employees know they’ll be paid out generously even after departure, that retention mechanism weakens.

On the flip side, aggressive repurchase policies can backfire. Paying out underperformers can spark resentment but so can deny long-tenured employees’ fair value at exit.

This is where consistency and communication come in. Whatever policy you adopt, apply it consistently and explain the rationale transparently. Employees don’t need to love the policy — they just need to understand it and trust it’s applied fairly.

A Practical Framework

To balance these competing interests, many companies adopt a three-part framework:

1. Default Rule
   Repurchase vested equity at FMV at termination. Employees are rewarded for value already created, but don’t share in future upside.
2. Exceptions with Approval
   Allow board-approved exceptions for special circumstances: retirement, death, disability, or individuals who had a transformative impact on the company.
3. Clear Communication
   Document the policy in plan documents, offer letters, and employee FAQs. Explain the rationale: equity rewards contributions while employed, not indefinite participation.

This framework provides clarity, fairness, and flexibility — while keeping the cap table manageable.

Common Pitfalls to Avoid

• Inconsistency: Applying rules differently for different people invites morale issues and legal risks.
• Liquidity crunch: Committing to repurchases without cash reserves can backfire if multiple terminations occur simultaneously.
• Poor communication: Surprising employees with unexpected treatment at exit erodes trust.
• Ignoring equity type: Profits interests, RSUs, and stock options may warrant different handling.

Best Practices from the Field

• Set thresholds: Only repurchase when holdings exceed a minimum value (e.g., $10,000).
• Use discounts carefully: If applying less than FMV, explain why.
• Independent valuations: Third-party appraisals reduce disputes and protect against bias.
• Revisit policies regularly: As the company grows, what worked at 50 employees may not work at 500.

Final Thoughts

Repurchase rights aren’t just a legal or financial decision. They’re a strategic choice about how your company defines ownership, contribution, and fairness.

There’s no universal playbook. The right policy depends on your equity type, cash flow, ownership philosophy, and leadership priorities. But there are guiding principles:

• Avoid free riders.
• Protect the cap table.
• Be consistent.
• Communicate clearly.

Ultimately, vested equity should reward those who help create value — without compromising the ability of current employees and shareholders to benefit from future growth.

A thoughtful repurchase policy ensures equity remains what it was always meant to be: a powerful, performance-driven incentive that aligns employees, leadership, and investors on the journey to long-term success.