Liquid Stock, with employee financing offerings for stock options, are among the liquidity providers benefitting from the unusual economic upset.
AirBnB was poised to take on an historic IPO in 2020 before travel and hospitality were rocked by COVID-19. Instead, the almost-debutante had to cut back a quarter of its workforce. When CEO Brian Chesky told Bloomberg in early June that an IPO was still not impossible by year’s end, it served to highlight a question for current and recently laid-off employees: ‘What should we do with our stock options?’
ESO Fund is one firm that helps employees exercise stock options. According to ESO Fund co-founder Scott Chou, “Some employees who remain with the company may receive an extension of their options or they may try to negotiate a new option grant. But a significant number of AirBnB people are shopping their options around now.”
Spurred by large swaths of layoffs amidst pandemic uncertainty, the Venture world is seeing a huge uptick in services that provide financing to cover stock option costs and associated taxes. Often, when an employee leaves a company they have 90 days to exercise their options. And buying out one’s options can be pricey—they’re also subject to capital gains tax.
Firms that offer solutions where employees can receive financing by exercising their options are gaining lots of traction in this climate. In return for their financing, the firms receive a chance to participate with the employee in a possible future exit of the company. Meanwhile, the employee keeps their rights to shares.
The aforementioned ESO Fund, for instance, raised its fourth $100 million fund in June. Liquid Stock, a San Francisco-based liquidity firm backed by Coller and Goldman Sachs, closed its first $161 million fund in January 2019 and has seen a steep uptick in dealflow in 2020.
Robert Pitti, a founding partner of Liquid Stock, was previously co-founder and partner with VSL Partners, which provided liquidity solutions to employees and shareholders of VC-backed late-stage companies. He explains that many of Liquid Stock’s transactions are, “structured like a loan, secured by the shares, but if the shares go to zero, the employee can walk away.”
Liquid Stock’s unique differentiator is that they work with companies to offer a solution for the whole workforce, managed separately through dedicated accounts. Their first fund invests in 15 to 25 companies through a hybrid of share liquidity deals and employee stock options. This enables both shareholders and employees to monetize equity without selling. Pitti says that, “In direct secondaries markets, bid-and-ask spread has widened substantially. People don’t want to sell out, but they also have cash needs.”
Another former partner at VSL, Steve Gold is co-founder and manager partner at 3SPOKE. He confirms that the current economic downturn has been “fantastic” for his firm. “Valuations are down. Any intelligent investor would rather invest today than three months ago,” he says. He plans to assemble a portfolio made up of roughly 20 growth-stage companies. Gold explains that 3SPOKE’s strategy is considered more growth equity than VC.
Meanwhile, ESO Fund’s model doesn’t offer shareholder liquidity at all. Instead, it transacts on a large amount of small employee stock option financings. The median deal is roughly $50,000. Although expensive to administer, smaller transactions provide for the possibility to back more companies and increase the odds for exits. Chou says, “Traditional VC’s have bigger returns, but our returns are more consistent. Before the coronavirus hit, we had a liquidity event on a weekly basis.”
According to ESO Fund, only about $500 million in employee stock options go up for sale in a given year. Chou says this is 100 times smaller than the liquidity market. He also says that Liquid Stock and 3SPOKE offer a kindred solution, but they normally conduct larger deals.
“The vast majority of our competitors want the traditional VC model where you build a portfolio of about 25 companies, each partner transacts once or twice a year but deploys many millions each time,” he says. “To pursue large deals, you have to do liquidity deals more often than just the options exercise cost.”
One LP, Warren Tye, an investment partner with Granite Capital Management, which has been backing ESO Fund since 2014, thinks that exits will slow down somewhat while secondary market opportunities increase for ESO Fund’s portfolio companies. Tye estimates that sales to other secondary buyers make up a third of all exits.
AirBnB, in fact, is likely to experience some secondary market interest. ESO Fund saw their distress and opted to take a chance on them anyway.
