As wealth managers working extensively within the pre- and post-liquidity planning environment, we often encounter situations with executives, founders, and early employees of startups and privately held companies that have tremendous wealth on paper but no liquid resources. In essence, they are asset rich and cash poor. In the past, if employees wanted to exercise equity before an IPO, there were limited options for shareholders, which meant they would likely have to absorb large tax payments and exercise fees out of pocket. This problem has plagued shareholders for decades and forced many private company employees to wait for an IPO to exercise.
Historically, shareholders have limited choices in exercising private stock. The problem is further exacerbated by rocketing internal 409A valuations, which make exercising increasingly expensive leading up to an IPO. With an average annual salary of below $200K,1 many tech employees cannot afford their exercise costs, which can run into the millions, and even C-suite executives may be challenged to come up with the cash required to exercise their options.
Further compounding this problem is the lack of alternatives for shareholders. Other options, like secondary market sales, not only can result in suboptimal tax consequences and broker fees, but they do not allow shareholders to participate in any potential growth of their stock. Often, these practices also violate share-transfer policies mandated by the company. We always advise clients to read the fine print when it comes to the restrictions of their holdings and talk with a CPA. Those in this position should start planning at least 6-12 months prior to any anticipated event and consider the bigger picture of estate planning as it relates to their overall balance sheet.
The Summa Group has coordinated with outside solution providers to help address these fundamental problems by providing the capital and liquidity education, in advance of approaching a liquidity event. In contrast with traditional loans secured by personal assets, clients can now acquire loans and funding contracts that are generally collateralized by private stock alone. A loan repayment is then triggered when the company has a liquidity event, such as an IPO or sale.
We have seen regular, programmatic, shareholder liquidity become a retention requirement for any top-of-the-line, late-stage company. This solution seeks to optimize tax, option exercise, and liquidity planning for these shareholders. The caveat here is size and scale. An outside liquidity provider will have to take on some degree of risk by providing these non-recourse loan products. Most will require a minimum $500 million market cap with large recurring revenue streams. Typically, we see providers require a minimum threshold of $50 million in recurring revenues. They will also require an accelerating upward sloping growth rate and will normally only lend on high-quality businesses as they will have to absorb any potential losses.
The bottom line is that this strategy allows employees to borrow against their private stock value without having to transfer or sell shares. This allows borrowers access to the capital they need while having the ability to benefit from any share appreciation. It’s these types of shareholder-first solutions that allows employees to borrow against their private stock value without having to transfer or sell shares.
It’s often said, “Great wealth is created through concentration and maintained through diversification.” We feel this is one of many smart liquidity tools for private stock shareholders. It solves a common pain point for employees at high-growth startups: the inability to afford extremely expensive option exercise costs before an IPO.
Robert Dalie is a financial advisor with Oppenheimer & Co. Inc., and his opinions do not necessarily reflect those of the firm. This article is not and under no circumstances to be construed as an offer to sell or buy any securities. The information set forth herein has been derived from sources believed to be reliable but is not guaranteed as to accuracy and does not purport to be a complete analysis. Opinions expressed herein are subject to change without notice.
Oppenheimer & Co. Inc. Transacts Business on all Principal Exchanges and Member SIPC.
