Start-ups/stock option: the pre-wealth effect

The story of the masseuse who took a job at Google in 1999 and received stock options that made her a millionaire is held up as proof of Silicon Valley’s legendary wealth creation. Tech start-up employees accept modest salaries in exchange for stock options they hope will one day make them rich. Delayed listings have driven demand for “pre-wealth management” services as workers wait to cash out. 

Last year, US-listed initial public offerings raised a record $167.7bn, according to data provider Dealogic. This should be a bonanza for employees. But San Francisco-based Secfi claims that more than half of employee stock options are not taken up because workers lack the necessary funds. This is particularly the case with highly valued, long-term private companies whose stock options come with a high exercise price. Airbnb spent more than a decade as a private company before listing in December. Palantir remained private for 17 years.

The number of IPOs is rising, but so is private funding. VC funding reaching a record $39.9bn in January, according to Crunchbase. This should support the employee stock option service sector. Companies such as Secfi, Quid and EquityBee offer forward purchase deals to buy options and cover tax payments. These are not repaid until there is a liquidity event — such as an IPO — at which point the company takes a portion of the upside. EquityZen, meanwhile, is a marketplace that allows employees to sell shares on a secondary market before their employer goes public.

Foot-dragging founders make employee stock options less attractive in compensation packages. Options help early stage companies preserve cash and attract the sorts of workers willing to link their financial future to the company. Delayed liquidity events devalue employee equity, raising the possibility that public valuations will not match private ones or options will expire. Airbnb’s IPO was propelled by the fact that some employee options were close to becoming worthless. One answer is for start-ups to start extending dates on employee stock options.

The Lex team is interested in hearing more from readers. Please tell us what you think of start-up stock options in the comments section below.