For Silicon Valley's potential startup millionaires, compensation packages staked on future promises of wealth are where the action is. But what happens when these employees get laid off or have to leave before an exit?
When Wouter Witvoet left a startup that he had joined as employee No. 4, he felt relatively prepared, having set aside $50,000 to exercise his available stock options, only to be informed by HR that he was also liable to pay taxes on said options so he was about $1.8 million short with 90 days to settle up.
"I ended up losing my entire equity stake," Witvoet tells TechCrunch.
Witvoet later founded Secfi, which is just one of a handful of entities looking to establish itself in the hot "pre-wealth" management space with what it calls forward purchase agreements, enabling startup employees to exercise stock options and wait until an IPO or exit to make payments.
Looking to leverage paper wealth is hardly a new trend, but more institutional investors are eyeing the non-traditional opportunity as high-growth startups get harder to access. For some of the hedge funds and private equity funds playing around in this space, these deals represent a back door into the paydays of mature IPO-bound startups, at a discount.
There are a number of players with hundreds of millions at play. Section Partners has $120 million in committed capital and calls its option exercise financing a "lifeline" for employees facing option expiration. Troy Capital Group's Quid has partnered with Oaktree Capital Management on a $200 million fund. The Bay Area ESO Fund has been providing this financing to startup employees since its founding in 2012.
Secfi, which has raised $7 million in venture funding from investors, including Rucker Park Capital, Social Leverage and the Weekend Fund, had previously been acting as a go-between for multiple firms, but is announcing today that they've partnered with New York hedge fund Serengeti Asset Management, locking down a $550 million debt facility.
Taking out run-of-the-mill loans to exercise options with the assumption that a great exit inevitably awaits your startup is an awful call. These forward purchase agreements are backed by the options themselves so the recourse is limited to the options in question. If your startup succeeds, you'll be paying the company back the principal, plus an interest rate and an equity rate, i.e. a good chunk of your upside. If your startup endures a WeWork-like fiasco, no one is coming after your car.
With more late-stage startups pumping the brakes on spending and eyeing layoffs, there aren't many great resources for affected employees looking to see what their options are worth. Many end up finding themselves going down Quora rabbit holes, browsing for information that is rarely one-size-fits-all. Educating on an individual basis has its merits, but most of these options-financing firms are also trying to get HR departments at companies to do a bit of the marketing for them through partnerships with the startups themselves.
As more money gets directed from these behemoth funds toward "pre-wealth" financial services, you can expect to see more startups like Secfi popping up, hoping to offer potential startup millionaires a platform that extends beyond the pathway to options' upside.