Amid economic uncertainty, many start-ups are being forced to make the difficult decision to lay off their workers. This has very real ramifications for option holders, many of whom lack the financial resources to exercise their options or may be hesitant to risk their personal savings for an unknowable amount of time. In fact, some studies indicate that more than 50% of options in private technology companies go unexercised.
As an option holder in a private growth company, it’s important to have a proactive plan to manage this important asset. The actions taken with respect to these options, and when they are taken, can have a significant impact on their value or whether they have any value at all.
Liquid created a Q&A to shed light on how the equity options market has reacted to this crisis and what you can do about it.
Why are option holders suddenly facing new deadlines?
Equity option grants usually have a ten-year expiration period. However, when an option holder leaves a company, either voluntarily or involuntarily, their options typically expire in 90 days. Many option holders do not have the capital or resources to exercise their options or do not want to risk other assets, so they leave their hard-earned equity on the table.
The economic uncertainty associated with the current crisis leads to more layoffs. This means more employees are faced with losing their equity unless they can come up with significant amounts of cash in a short period of time. The problem only gets worse as the pace of layoffs increases.
What happens when the economy begins to stabilize?
When layoffs slow down, more employees will conclude that they’d rather be shareholders as opposed to option holders. Having seen friends or colleagues lose their jobs and their equity, option holders will be looking to exercise their options as early as possible so they can own their shares since these exercised shares are portable (cannot be forfeited). Companies have plenty of incentive to help employees exercise their options, which can soften the blow of layoffs, promote an employee friendly culture and generate valuable working capital for the company.
Liquidity is at a premium in today’s market environment. Employees who already own their shares are increasingly looking for ways to generate liquidity to diversify, reduce risk and meet living expenses. In the recent past, private company shareholders may have been able to sell a portion of their private company shares to a secondary buyer or, in some cases, back to the company. The current environment makes it more challenging to sell private shares since it’s difficult for buyers and sellers to agree on price. Even if there are willing buyers at a price, selling at a low price today may not be appealing if shareholders believe their company’s value will rebound.
What are the risks associated with traditional paths to liquidity?
In the past, liquidity solutions for those requiring capital were typically offered as either a loan or as part of a direct tender (sale) offer.
Each of these traditional but inflexible paths to liquidity come with disadvantages: recourse loans have fixed maturities and put personal collateral assets at risk, while a tender offer naturally means you are no longer availed of the upside in the value of the company. Both of these choices may also have adverse tax consequences that greatly reduces the end value of the transaction.
Instead, Liquid Stock provides a tax efficient, non-recourse financing alternative that is secured by the exercised shares themselves. Liquid Stock financing is only paid back if there is a future IPO or other company liquidity event. It also takes into account the risk of company failure and provides the capital necessary to cover the cost of exercise and the related taxes. So, unlike the traditional choices, our financing is designed so that our interests are always aligned with our clients’.
What can tech companies do to mitigate current market forces?
We face a tough situation right now as companies and investors adjust to the new environment. In this uncertain period, companies can help their current (and former) employees by offering a non-recourse financing plan as a solution. As a matter of corporate responsibility, they should aim to ease the pain associated with an involuntary termination and the anxiety of being an option holder by helping option holders become shareholders.
It’s about finding the right path to liquidity that does not involve selling stock today at a discount, or otherwise reducing an employee’s equity stake in the company.