As wealth managers working extensively in the pre- and post-liquidity planning environment, we often come across situations with executives, founders and early employees of startups and private companies who have enormous wealth on paper. but no liquid resources. Essentially, they are rich in assets and poor in cash. In the past, if employees wanted to exercise their stocks before an IPO, options for shareholders were limited, which meant they likely had to absorb large tax payments and exercise fees out of pocket. This problem plagued shareholders for decades and forced many employees of private companies to wait for an IPO to practice.
Historically, shareholders have had limited choices in exercising private actions. The problem is further compounded by the skyrocketing internal valuations of the 409A, making the increasingly expensive exercise leading up to an IPO. With an average annual salary of less than $ 200,000,1 Many tech workers can’t afford their exercise costs, which can run into the millions, and even senior executives can be challenged to find the cash to exercise their options.
The lack of alternatives for shareholders further compounds this problem. Other options, such as secondary market sales, not only can result in sub-optimal tax consequences and brokerage fees, but they do not allow shareholders to participate in the potential growth of their stocks. Often, these practices also violate company-mandated stock transfer policies. We always advise clients to read the fine print regarding restrictions on their holdings and speak with a CPA. People in this role should start planning at least 6 to 12 months ahead of any planned event and consider estate planning as a whole in relation to their overall balance sheet.
The Summa Group has coordinated with external solution providers to help address these fundamental issues by providing capital and liquidity education, ahead of a liquidity event. Unlike traditional loans secured by personal assets, clients can now acquire loans and finance contracts which are usually secured by private equity only. A loan repayment is then triggered when the business has a liquidity event, such as an IPO or a sale.
We have seen regular, programmatic shareholder liquidity become a retention requirement for any high-end, early-stage business. This solution aims to optimize taxation, the exercise of options and liquidity planning for these shareholders. The caveat here is size and scale. An outside liquidity provider will have to assume a certain degree of risk in providing these non-recourse loan products. Most will require a market cap of at least $ 500 million with significant recurring income streams. Typically, we find that vendors require a minimum threshold of $ 50 million in recurring revenue. They will also need an accelerated and upward growth rate and will normally only lend to high quality companies as they will have to absorb any potential losses.
The bottom line is that this strategy allows employees to borrow against the value of their private stocks without having to transfer or sell stocks. This allows borrowers to access the capital they need while still having the opportunity to benefit from any appreciation in stocks. It is these types of shareholder-driven solutions that allow employees to borrow against the value of their private stocks without having to transfer or sell stocks.
It is often said: “Great wealth is created by concentration and maintained by diversification. We believe this is one of the many smart liquidity tools for private shareholders. It solves a common problem for employees of 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 views do not necessarily reflect those of the company. This article should in no way be interpreted as an offer to sell or buy securities. The information in this document has been obtained from sources believed to be reliable, but its accuracy is not guaranteed and does not claim to be a complete analysis. The opinions expressed here are subject to change without notice.
Oppenheimer & Co. Inc. does business on all major stock exchanges and SIPC members.