Estimating stock option forfeiture rates: a simple, defensible guide for founders

What Is a Stock Option Forfeiture Rate and Why Does It Matter?

Calculating your stock option forfeiture rate can feel like a task deep in the accounting weeds, yet getting it wrong has direct consequences for your financial narrative. Misstated forfeiture rates can distort your stock-based compensation expense and key performance metrics, undermining credibility with investors and auditors. For founders managing runway and planning for the next fundraise, an unexpected expense adjustment can be a significant setback. This guide provides a practical, stage-by-stage approach for how to estimate stock option forfeiture rates, helping you move from simple benchmarks to a data-driven model without a full-time finance team. See our Stock Option Accounting hub for related guides.

A stock option forfeiture rate is an estimate of the percentage of unvested stock options that will be cancelled because an employee leaves the company before their options fully vest. Under accounting standards, this estimate is crucial for accurately reporting your expenses. The goal is to match the cost of employee services (paid in equity) to the period in which those services are provided. By estimating forfeitures upfront, you avoid overstating your compensation expense for options that will likely never vest.

This accounting exercise becomes a formal requirement as soon as you begin issuing equity. For US companies, "Forfeiture rate estimates are used to calculate stock-based compensation expense under ASC 718." In the UK, the equivalent standard is IFRS 2, which requires a similar approach to estimating forfeitures. The need for formal option expense accounting typically begins with your first 409A Valuation and the initial wave of option grants, as this is the point where the equity has a defined value and becomes a material part of your compensation strategy.

How to Estimate Stock Option Forfeiture Rates: The Benchmark Method

For a seed-stage company with limited operating history, developing a complex, data-driven forfeiture rate is impractical. In this phase, using an industry benchmark or a 0% rate is a perfectly acceptable starting point. It provides a simple, defensible position that satisfies initial accounting requirements while you build the necessary historical data.

Starting with a Simple Benchmark

A benchmark rate is an estimate based on industry averages or the experience of similar companies. For early-stage SaaS or Biotech startups, a forfeiture rate between 5% and 15% is often considered a reasonable starting point. The key is to choose a rate and document the rationale behind it. For example, a Deeptech company with highly specialized R&D roles might justify a lower rate (e.g., 5-8%) due to expected lower turnover, while a high-growth E-commerce company with a large sales team might justify a higher rate (e.g., 10-15%).

Alternatively, US companies following GAAP have the option to elect an accounting policy of recognizing forfeitures as they occur. This means assuming a 0% forfeiture rate and then adjusting for the full expense reversal only when an employee actually leaves. While simpler in the short term, this approach can create more volatility in your stock-based compensation expense from period to period. This election must be applied consistently to all stock-based awards.

Why and When to Move Beyond Benchmarks

Using a benchmark is a good starting point, but it isn’t a permanent solution. As your company matures, auditors and investors will expect your financial assumptions to mature as well. Relying on generic data for too long can suggest a lack of financial sophistication and internal controls, which can become a point of concern during due diligence. Deloitte often publishes practical roadmaps on ASC 718 application that highlight the importance of evolving assumptions.

So, what is the milestone that forces the change? The trigger to move from benchmarks to internal data is typically having two to three years of reliable employee turnover data. This is the point where you have enough history to build a credible estimate based on your company’s actual experience rather than industry averages. For a venture-backed startup, this often coincides with preparing for a Series A or Series B fundraise, when financial scrutiny becomes more rigorous. Useful external context on broader turnover trends can be found in public data sources such as the BLS JOLTS release.

The primary risk of not evolving your methodology is a future restatement. If an auditor determines your forfeiture rate estimate is no longer reasonable, you may be required to make a significant “true-up” adjustment. This can create a sudden spike in expenses, negatively impacting your P&L and potentially disrupting cash-flow plans and runway calculations. Proactively updating your model demonstrates sound financial management and a commitment to accurate reporting.

Building a Data-Driven Model: How to Estimate Stock Option Forfeiture Rates from Your History

Once you have two to three years of data, you can build a simple, powerful model using your own history. This is far less daunting than it sounds and primarily requires organizing data you already have. Your cap table platform (like Carta or Pulley) and your HRIS (like Gusto or Rippling) are the sources of truth for this analysis. At its core, the calculation is straightforward and provides a much more defensible figure for your financial statements.

A Step-by-Step Guide to Calculating Your Historical Rate

The process involves gathering specific data points and applying a clear formula. A methodical approach ensures the resulting rate is both accurate and auditable.

1. Gather Your Data: Export reports from your cap table and HR systems. You will need a complete record of all option grants, including the grant date, vesting schedule, and number of shares. You also need a full list of employee terminations, including their termination date.
2. Define the Period: Choose a historical period for your analysis. A 24-month or 36-month look-back period is common as it provides a stable base of data while still reflecting recent company trends.
3. Apply the Formula: The basic formula for a historical forfeiture rate is: (Number of unvested shares forfeited in a period) / (Total unvested shares at the start of the period + New grants made during the period).

You would typically calculate this on an annual basis. For example, consider a SaaS startup’s engineering department:

• Unvested shares on Jan 1, 2023: 200,000
• New unvested shares granted in 2023: 50,000
• Total denominator: 250,000
• Unvested shares forfeited during 2023 (from departing engineers): 15,000
• Annual Historical Forfeiture Rate: 15,000 / 250,000 = 6%

This 6% rate becomes your new, internally-derived estimate for calculating future stock-based compensation expense. It reflects the actual turnover behavior within your company, making it a much stronger assumption than a generic benchmark.

Refining Your Model with Cohort Analysis

A scenario we repeatedly see is that a company’s actual turnover rate differs significantly from benchmarks, especially in high-turnover departments like sales versus more stable R&D teams in a Deeptech company. This leads to the next level of precision: cohort analysis.

While an entity-level rate is a great step forward, cohort analysis is considered best practice once a group is large enough to be statistically meaningful (e.g., 50+ employees in a department). This involves calculating separate forfeiture rates for different employee groups. Common cohorts include:

• By Department: Sales vs. Engineering vs. Marketing.
• By Seniority: Executive vs. Individual Contributor.
• By Grant Date: Grouping options granted in the same year to see if tenure patterns have changed over time.

This approach provides a much more accurate forecast of your stock option expense, as it reflects the unique turnover patterns within your organization. When grouping cohorts, you should also consider your vesting schedules, as different schedules can influence forfeiture patterns.

Maintaining Your Forfeiture Rate: The Annual Review Process

Estimating a forfeiture rate is not a one-time task. It is a living assumption that must reflect the current and expected reality of your business. As a general rule, forfeiture rate assumptions must be reviewed and, if necessary, updated at least annually. This review should be a standard part of your year-end closing process, ensuring your financial reporting remains accurate.

However, certain business events should trigger an immediate review, regardless of your annual cycle. These include:

• A significant reduction in force or layoff: This event will cause a large number of forfeitures in a short period and may change the retention outlook for remaining employees, likely requiring an immediate update to your estimated rate going forward.
• A major strategic pivot: If your company changes direction, you may anticipate higher or lower turnover in specific departments as roles and priorities shift.
• Completion of a major R&D milestone: For a biotech company, a successful clinical trial might dramatically increase employee retention and lower the expected forfeiture rate. Conversely, a failed trial could have the opposite effect.

Failing to keep the estimate current can lead to the same problems as failing to move off benchmarks, namely surprise adjustments. When you update your rate, you will record a cumulative “true-up” to adjust prior period expenses to what they would have been had you used the new rate all along. A disciplined annual review process smooths out these adjustments and prevents financial reporting surprises that can complicate investor conversations and budget planning.

Stage-by-Stage Guidance: From Seed to Series B

Translating accounting theory into action depends entirely on your company’s current stage. The goal is not perfection from day one, but a progressively more accurate approach that matches your operational maturity. What founders find actually works is focusing on the single most important action for their stage.

For Seed-Stage Companies

Your priority is data integrity. Start with a defensible benchmark rate (e.g., 5-10%) or, if in the US, consider a 0% policy and document your choice. Your most important task is not the calculation itself, but ensuring your HRIS (like Gusto or Rippling) and cap table software (like Carta or Pulley) are meticulously maintained. Clean, accurate records of grant dates, vesting schedules, and termination dates are the foundation for all future analysis. Your next immediate step is to confirm these systems are accurate and reconciled. For practical steps on system integration, see our guide to the Carta accounting sync.

For Series A Companies

This is the transition period. With likely two or more years of operating history, it’s time to test your own data. Begin by exporting grant and termination history into a spreadsheet. Run the simple historical rate calculation described above for the company as a whole. This initial analysis will tell you if your internal data justifies moving away from benchmarks. It also prepares you for the deeper diligence questions you will face from new, more sophisticated investors who will want to see the assumptions behind your numbers.

For Series B Companies and Beyond

At this stage, a historical, data-driven forfeiture rate is the expectation. You should be using a documented, internally-derived rate, likely broken down by employee cohort. The key here is process. Your annual review of the rate assumption should be formalized and documented to provide a clear audit trail. This demonstrates strong financial controls and provides a more reliable basis for your stock-based compensation forecasting, a key input for your overall budget and runway management. For further reading on international requirements for share-based payments, see the IFRS Foundation guidance.

For more resources, please see the broader set of guides in our Stock Option Accounting hub.

Frequently Asked Questions

Q: What is a typical stock option forfeiture rate for a startup?
A: Early-stage startups often use benchmark rates between 5% and 15%. The appropriate rate depends on the industry and employee profile. For example, a tech company with high sales team turnover might use a higher rate than a deeptech firm with a stable R&D team. This benchmark should be replaced with company-specific data after 2-3 years.

Q: Can I just use a 0% forfeiture rate?
A: Under US GAAP (ASC 718), companies can elect an accounting policy to account for forfeitures as they happen, effectively using a 0% rate. This simplifies the initial estimate but can cause more volatility in your expense recognition. This policy choice is not available under IFRS 2, which requires an estimate.

Q: How does a high forfeiture rate impact my financial statements?
A: A higher forfeiture rate reduces the estimated stock-based compensation expense recorded on your income statement each period. This is because you are anticipating that a larger portion of grants will be cancelled. While this results in lower reported expenses initially, it requires a robust, data-driven justification to be accepted by auditors.

Q: What's the main difference between ASC 718 and IFRS 2 for forfeitures?
A: The primary difference is that ASC 718 (US GAAP) allows an entity-wide accounting policy election to either estimate forfeitures or recognize them as they occur. IFRS 2 (used in the UK and elsewhere) requires all companies to estimate an expected forfeiture rate and update it based on new information.