[jedberg]

Most decent companies will make it up to you by issuing you new options with the same value or otherwise compensating you for the expiration of options you can't exercise, in some cases they will simply buy the shares from you, giving you your "exit".

[zzalpha]

So while the employer could issue new options at a discounted strike price, it has serious tax consequences. From http://www.lexology.com/library/detail.aspx?g=d9f306b0-a209-...:

Unless the ability to exercise such a “discounted” stock option is limited to certain predetermined events or specified dates, the option is taxed as soon as it vests, regardless of when it is exercised or whether it was intended to be a non-qualified or incentive stock option.

Now, you could try backdating, but that's probably ruled out by the option plan, and could be viewed as fraudulent depending on circumstances.

Of course, the employer can issue new options based on the current FMV of the company... but for anyone in this situation, that probably means a substantial loss as the new strike price will match the current valuation of the company.

As for paying the employee out, I've never heard of that happening in practice... and it has its own pros and cons, the most obvious being that you're now out of the game if there's a subsequent liquidity event.