- Secondary markets let shareholders in startups sell before the companies go public.
- Insider spoke with three current and former startup employees who had used such services.
- One ex-employee gave up 50% of his equity so that he could exercise his options and cash out.
- See more stories on Insider’s business page.
In April, Ashley Lewis was under pressure to come up with a large sum of money.
She’d recently left a startup and had three months before her stock options expired. Exercising them so that she could buy the stock meant paying a fortune up front for shares that could make her wealthy someday, or end up worthless.
“There’s a ticking clock once you leave the company,” she said.
Lewis had heard about secondary markets — services that let people sell their shares or get money for their stock options before the companies go public — but knew little about how they worked.
On Reddit, she asked if others had encountered any hiccups using them. Her post resulted in several offers from would-be investors.
In the end, she opted for two services. She’d use her own money to exercise some of her options and sell them on an exchange called EquityZen. Then she’d use a service called EquityBee to fund buying the remaining portion. This way, she could get immediate cash but still hold on to some shares in case their value increased.
There’s a catch
Startup employees often receive part of their compensation in stock. But they can’t sell that stock until the company is acquired or goes public, which typically means waiting years for a financial benefit. Many workers are hungry to cash out on their own timetables, not their company’s.
That’s where secondary markets come in. They typically operate under one of two business models: arranging sales of shares between sellers and buyers, as EquityZen does, or providing startup employees money to exercise their options, as EquityBee does. (See: Startup employees have lots of ways to sell their stock early on ‘secondary’ markets. Here’s what to watch out for.)
Lewis’ transactions haven’t been finalized, but so far, she told Insider, the process has been easy to navigate.
“Going to their website, it’s easy to see how they operate,” she said of both EquityBee and EquityZen. “I got the sense that you could trust them.”
But a cut-and-dried process isn’t guaranteed. Selling shares outright also requires approval from the startup, which often has the right to make an offer first or even block the sale, though Phil Haslett, EquityZen’s founder, told Insider that blocked sales are rare.
Services that front the cash to employees for exercising options typically don’t need the startup’s approval, as shares don’t transfer until after an initial public offering or another exit. But the lender may gobble up a big chunk of the seller’s profits, whereas secondary share exchanges take a smaller transaction fee.
EquityBee, for instance, may take 5% to 40% of the share proceeds, depending on the startup’s performance at the time of the original transaction, Oren Barzilai, the exchange’s CEO and cofounder, told Insider.
Forking over 75% but coming out ahead
One former startup employee told Insider he ended up netting just one-quarter of the value of his shares after two secondary transactions.
It was late 2015 when he left the company. He needed more than $100,000 to exercise his options and had just 90 days to do so.
So he turned to a company that provides “non-recourse loans” to startup employees for options and taxes — meaning that if there was no exit, he wouldn’t have to pay back the money.
The company offered the former employee the money he needed for about 50% of his stake in the startup, he told Insider. Despite the hefty percentage, he jumped at the offer.
“At the time, it was worth it to me,” he said. “Either I had the ability to get my shares or not.”
More than four years later, in 2020, an investor running another secondary fund contacted him about buying the shares he obtained in that transaction. The ex-employee sold to the investor but wound up paying about 75% of what he’d made to the original lender and in taxes.
A few months later, he saw shares of the startup, which was rumored to be pursuing an IPO, climb even higher on some secondary platforms.
“I’m kicking myself because I sold way too early,” he said.
Even so, he added, he wound up making enough money on the 25% of the proceeds he’d kept to make a down payment on a home.
‘Do that math’ before the sale, one startup employee says
Priyank Chodisetti, an engineering manager at a Silicon Valley tech startup, also felt that the fees were worth it, as he wound up with shares worth millions of dollars after his company went public.
Years ago, he was able to sell a portion of his options back to his company during a sale authorized and run by the startup.
But he felt that his remaining options kept him bound to the job because he couldn’t afford to exercise them all at once if he left. Having previously founded a startup, Chodisetti figured he might want to leave his job someday to launch another.
So he looked for a way to quickly convert his remaining options into shares so he could keep his equity even if he left. Plus, exercising his options early would let him take advantage of lower tax rates.
In 2018, Chodisetti turned to a secondary fund for the money he needed and negotiated a lower equity percentage fee from the lender, allowing him to keep most of the proceeds.
“I felt truly liberated,” he said. “On one hand, it was a hard decision because of the big cut I was giving. But I could quit any day I want.”
While Chodisetti is happy with his outcome, he said he might have done things differently had he waited a little longer. He’s since found that other secondary markets offer better terms than the ones he received, so shopping around for the best deal is prudent, he said.
Also, Chodisetti said, option holders need to weigh the pros and cons of exercising early using such services. While doing so could set them up for lower taxes, since they’d hold on to the shares longer, they may be giving up equity unnecessarily if they end up staying at the company through its exit.
“People should really do that math,” he said.
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