Stripe has been one of the most anticipated prospective IPOs in recent years, but when IPO activity slowed in 2022, the likelihood of Stripe going public in the near future decreased. This created new challenges for the company, which had granted equity that might expire before the IPO window reopened. Stripe reacted by raising a $6.5 million down round and conducting a tender offer, to provide employees with liquidity for their company equity and to allow the company to accelerate the vesting of Restricted Stock Units (RSUs) and cover the resulting tax obligations.1 The financing brought attention to the challenges facing countless late-stage private companies with expiring equity grants and stalled exit opportunities.
Why did the Stripe Round Involve a Tender Offer?
Stripe has issued equity to employees since its inception in 2010, initially granting stock options and later RSUs, both with expiration dates. To avoid forfeiture, option-holders need to exercise before their options expire no later than the 10-year anniversary of the grant. RSUs work differently. At companies like Stripe, RSUs are typically “double-trigger”, meaning that they fully vest after the lapse of a particular time period (often 4 years) and the close of an exit event, such as an IPO or acquisition. If both triggers are not met by the RSU expiration (often 7 years), the RSUs are forfeited.
To address expiring RSUs, Stripe accelerated the RSU vesting by waiving the liquidity event trigger.2 This created a new obstacle since vesting of RSUs generates ordinary income tax, and with the company still private, employees would not be able to sell shares to cover the cost. By conducting a financing and tender offer in connection with the RSU modification, Stripe allowed employees to sell shares necessary to cover the tax liability. The tender offer also provided liquidity to those who needed to cover option exercise taxes or had been waiting to cash out on owned shares.
A Growing Challenge
Stripe is not the only company that has faced or is currently facing these challenges. With the time to go public increasing over the past decade, and the IPO window still firmly shut, many of Silicon Valley’s most valuable private companies are dealing with expiring equity awards or employees growing impatient with the wait for liquidity.
How Can Companies Address Expiring Equity Awards?
There are various possible solutions for companies and equity holders facing grant expirations, but each poses challenges and trade-offs, including potential tax, accounting, and legal impacts. Strategies include:
Alter Grant Terms: Tax rules make it difficult to solve option expiration by changing the terms of the grant.3 Extending the expiration date beyond ten years isn’t feasible, as it results in taxation of the option plus penalties.4 Extension is also difficult for RSUs, which are required to have a “substantial risk of forfeiture”, in order to delay their taxation.5 A company may waive the second trigger of a double-trigger RSU, as Stripe did,6 but that will trigger tax obligations that are difficult for employees to cover unless they are permitted to sell or finance against the shares with a third party, or the company is willing to withhold shares to cover the taxes (requiring a substantial cash outlay from the company). Additionally, this approach can’t be used as a regular practice, as it could violate the substantial risk of forfeiture requirement for company RSUs, leading to a potential tax burden for holders of both outstanding RSUs and RSUs granted in the future.7
Issue New Grants: A company could issue new options or RSUs to make up for expired grants, but this solution has limitations. Any new stock options would need to be granted with an exercise price equal to the current fair market value, wiping out prior gain. RSUs could potentially be used to make up for expiring options, but the recipient may end up with fewer shares, decreasing their ability to participate in future upside.8 New RSU grants could replace expiring RSUs, but replacement awards might be viewed as extending the original RSU term, leading to negative tax impacts.9 Additionally, it may not be possible under most company equity plans to issue new grants to individuals who are no longer service providers of the company, meaning this solution will only help current employees.10
Pay Bonuses: As Instacart recently demonstrated,11 another option is to award cash bonuses to employees in an attempt to make up for expiring grants. It may sound like an easy solution, however, companies are unlikely to have sufficient cash to pay out bonuses large enough to make up for the value lost from expired options or RSUs. If the expiration problem is large-scale, the company will likely have to make difficult choices about whom to grant bonuses to. Lastly, this is another solution that only addresses grants held by current service providers, leaving prior employees out of luck.
Allow Secondary Transactions and Tender Offers: A popular solution is to allow employees to sell shares to investors to cover taxes on exercised options and accelerated RSUs. This requires the company to waive transfer restrictions and to adhere to strict rules if structured as a tender offer. However, not all companies have access to interested buyers in today’s market. Companies that do, like Stripe, may opt to allow chosen investors to purchase shares through a tender offer, but most companies are hesitant to permit ad hoc secondary transactions. Unrestricted secondary sales can result in unknown parties on the cap table and trigger public reporting obligations if the number of shareholders exceeds the maximum permitted.12
Provide or Permit Loans: Companies may provide loans or permit third-party lenders to provide loans to employees to cover the cost of exercising stock options and paying taxes associated with option exercise or accelerated vesting of RSUs. While loans can assist employees, they are typically recourse, meaning a recipient’s personal assets are at risk if they cannot repay the loan. If the company provides the loans, they must be at least partially recourse.13 In today’s economic climate, with the value of startup equity uncertain and equity-holders experiencing more economic constraints, this can be a significant risk.
Do Nothing: Companies that find the cost and complexity of addressing the expiration issue too high, may allow equity grants to expire as Foursquare did.14 This can damage a company’s recruitment efforts, workplace morale, and public image. But in today’s challenging market, it may be tough for many firms to pursue more generous solutions, especially if they cannot raise substantial new funds.
Facilitate Liquidity Transactions: Companies may facilitate a private stock liquidity solution, a transaction in which a third party provides funding to the equity holder to cover option exercise costs or as liquidity for owned shares, which differs from a loan. The shares collateralize the transaction and serve as the provider’s only recourse.15 These transactions are often more tax efficient than a loan and can cause less worry due to their non-recourse nature. Unlike a secondary sale, private stock liquidity transactions do not involve a transfer of shares, so they can relieve cap table concerns for companies. Some liquidity providers work with companies to facilitate transactions for many team members. These solutions may not be available to every interested employee, but often work well for early employees and executives, and can be utilized alongside other solutions.
How Can Liquid Stock Help?
At Liquid Stock, we provide liquidity and option-exercise solutions to private company equity-holders and can work directly with companies to facilitate our solutions on a larger scale. Our expert team aligns with companies, equity holders, and their advisors to develop innovative and tailored solutions. If your company is tackling equity-grant expiration challenges, reach out to learn more.
15 As used herein, “non-recourse” means that a transaction counterparty is not personally liable for the difference between the value of the advance made to the counterparty and the value of the collateral shares upon a liquidity event or upon such other time(s) as defined in the transaction agreement, if the value of the collateral shares is less than the advance or other amount owed. In Liquid Stock transactions, the Counterparty will be personally liable in certain enumerated “Events of Default” defined in the applicable transaction agreement. These events include but are not limited to, failure to pay amounts owed under the agreement when due, breach of representations and covenants, and transfer of collateral shares in violation of the transaction agreement. Following such an “Event of Default,” a transaction counterparty may be personally liable for the entire amount due under the agreement, even if it exceeds the value of the collateral shares.
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