- Startup employees typically get part of their pay in stock. But that stock cannot easily be sold.
- Secondary markets help them find buyers or borrow money to exercise stock options.
- But some secondaries charge hefty fees, or startups can block transactions.
Most startups offer their employees stock or stock options as part of their compensation. A decade ago, employees didn’t have many ways to turn that stock into cash until their company was sold or went public.
And if they couldn’t afford to exercise their stock options, they could be out of luck altogether.
Now there’s a growing array of secondary funds and exchanges to help employees sell early or finance their options. Some are well known and respected. Others operate much more in the shadows.
EquityZen and Forge Global, for example, are two well-known secondaries that arrange sales of shares between sellers and buyers on their platforms for a transaction fee.
Because startups are private companies, meaning their stock isn’t available for everyone to purchase, employees pretty much can’t sell without the company’s permission.
Both Forge Global and EquityZen verify that sellers have rights to the shares and that the company approves the sale. Forge used to conduct transactions known as “forward contracts” that bypassed that process, but it discontinued those sales earlier this year, Jose Cobos, its chief operating officer, told Insider.
About 10% to 20% of the time, the startups opt to buy the shares themselves, Phil Haslett, EquityZen’s founder and chief revenue officer, told Insider. Only rarely is a sale blocked, he said.
If the startup is OK with selling to others, EquityZen and Forge may aggregate the funds from participating investors into a special-purpose vehicle so that when the sale is completed only one new entity appears on the startup’s cap table.
Money to exercise options, pay taxes
EquityBee, Liquid Stock, and ESO Fund offer startup employees funding to exercise stock options or pay taxes on them. When employees leave a startup, they typically have 90 days to exercise options, or they lose them.
The employees pay back the initial funds plus a percentage of the proceeds from the resulting shares after the startup goes public or is acquired.
If there isn’t an exit, the employees don’t have to pay the funds back. Getting funding to exercise options doesn’t typically require the startup’s approval, since the employee holds on to the shares after the transaction. But the secondary takes a cut after the exit as either a portion of the actual shares or the equivalent cash value.
How much this costs an employee largely depends on the company’s perceived prospects at the time of the transaction, secondary operators said. (See: 3 startup employees dish on the win-or-lose game of using ‘secondary’ markets before an IPO)
On EquityBee, employees of the most coveted startups might give up what amounts to 5% of their holdings, while those with options in companies with lukewarm demand might have to fork over up to 40%, Oren Barzilai, the exchange’s CEO and cofounder, told Insider.
EquityBee maintains a list of the hottest private companies as determined by its community of some 8,000 investors who name the startups they’d like to buy into.
On Liquid Stock, shareholders may pay a percentage between 10% and 20%, Robert Pitti, the fund’s founder, told Insider. They also pay an “investment return” fee of 4% to 6% of the original funding upon the company’s exit.
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