Thanks for taking the time to comment.

Risk to employee. The point here is that when exercise prices become non-trivial (i.e. the cost of a new car), early-exercise no longer seems like a good idea.

Tax upon spread. Employees often do not early exercise their shares until they have been at the company for some period of time (and realize whether the risk to purchasing the shares is warranted). In that situation, there may be spread.

“Back door” public company. You're right, employees can always exercise their vested shares. The point is where a company sets up a culture of early exercise, things get dicey with the '34 Act.

Securities law issues. Having to do a CA fairness hearing or an S-4 will add at least a month and a half of time until closing and I'd guess about $75K in extra legal/accounting fees for a fairness hearing and significantly more for an S-4.

Administrative hassles. Almost all venture backed private companies issue stock certificates. They have a tendency to get lost, which is a pain to deal with.

Stockholder rights. You're flat out wrong here. The certificate of incorporation needs to be amended to create the new series of preferred stock in a typical venture financing. Stockholders of the company need to approve an amendment — and even if all stockholders are not solicited if their votes are not needed, they need to be give notice of the action (at least post-facto). There is always a sensitivity to sending out notices/info to employee stockholders.

For startups, providing early-exercise weakens employee retention. Thus, the biggest reason not to offer it is to increase retention.

Consider an employee who joins a startup when early-exercising their shares costs $200. Five years later, their shares are valued at $800,000+ but still illiquid. The spread at this later point creates an inconvenient situation for the employee, where exercising them may have expensive tax consequences even though the shares can not be sold to produce profit. The employee has become an indentured servant. It's not a reasonable financial choice to leave and give up the profit, but it's also not necessarily possible for them to afford purchasing the shares and pay the taxes. They are stuck, with no leverage, and no information about when the shares may be liquid and able to be sold. The company is happy, because the employee has the greatest incentive to stay with the company.

Let's talk about how the article misrepresents some of the points.

Risk to employee. ALLOWING early exercise does not create risk to the employee. The only risk is created when the employee actually decides to early exercise. Allowing it simply creates more flexibility for the employee. Further, early-exercise minimizes risk to the employee by allowing them to exercise the stock at the lowest possible price. Even without early exercise, the employee is free to exercise option as they vest. At that point, the exercise creates increased risk, in the form of tax upon spread.

Tax upon spread. If tax upon spread is bad, then early exercise is good. There are only two times a stock has no tax-spread-risk. At the beginning, when the purchase price is the same as the value, as in an early-exercise; and at the end, during a same-day sale when the stock is liquid. All the time in the middle involves spreads which are potentially dangerous for the employee from a tax perspective. More importantly, these tax consequences don't effect the company at all.

“Back door” public company. Disallowing early exercise does not disallow exercise. In order for preventing early exercise to be an effective means to stave off being forced to file public financial reports, employees must choose not to exercise options as they vest. The primary reason they would avoid exercising as they vest is the increased risk or tax-on-spread risk. These reasons put them further and further into indentured servitude, but don't reliably help the company prevent being forced to file public financial reports. If this is the company goal, a better means would be avoiding employee ownership of either stock or options. This issue is only applicable to startups, as large public companies are already filing publicly.

Securities law issues upon a sale. This is a red herring. This is not a real reason that acquisitions don't complete, or even the major issue in legal bills or costs in handling an acquisition. It simply doesn't matter.

Administrative hassles. Again, red herring. This is not a significant burden or cost. Startups can offer early exercise with ease. As employee count grows, it's true the administrative burden grows. However, there are much larger risks in a company than this minor clerical issue. Stock certificates? They don't need to be issued at all in private companies. It can simply be a paper or electronic ledger. Some of these points seem relevant if we were talking about a large public company, but we were not just talking about preventing 'back door' public financial filings?

Stockholder rights. Again, false and red herring. Every venture financing does not require amendment of the certificate of incorporation. At least not if the incorporating lawyers did their job correctly. Further, incorporation bylaws don't need to require minor shareholders to 'vote' to approve a financing event as long as they receive a majority of votes in support. This is simply a non-issue for financing.

Spread is a reason to allow early-exercise not disallow it. The minimum spread occurs when the options are originally issued, which requires early-exercise to take advantage of. Without early-exercise, an employee is forced to wait until

* Tax upon spread: Is there ordinary income taxation in the case of an ISO? Is there AMT liability in the case of an NSO?

* “Back door” public company: How does this effect my decision to exercise my shares early in either the NSO or ISO case? How does this effect the company's decision to offer early exercise in either the NSO or ISO case?

* Administrative hassles: What do you mean by “unvested shares must be kept by the company”? Do holders of exercised but unvested stock also have more voting rights than holders of unexercised but vested options? Does exercised but unvested stock have the same voting rights as exercised vested stock?