TRADERS Q&A: Robert Pitti, Liquid Stock04.21.2020
Stock options are an important currency in the private technology company ecosystem.
These securities provide a critical incentive and a path to equity ownership for employees, who are motivated to perform when they have a tangible stake in their company’s success. Leading private companies understand their employees are their most valuable assets and seek to promote a culture of ownership. For employees, this equity stake is usually their largest financial asset. However, many employees do not fully understand the nature of their equity options and find it difficult to make informed decisions.
As an option holder in a private growth company, it’s important to have a proactive plan to manage this important asset. The actions taken with respect to these options, and when they are taken, can have a significant impact on their value or whether they have any value at all.
Enter the COVID-19 pandemic.
Amid economic uncertainty, many start-ups are being forced to make the difficult decision to lay off their workers. This has very real ramifications for option holders, many whom lack the financial resources to exercise their options or may be hesitant to risk their personal savings for an unknowable amount of time. In fact, some studies indicate that more that 50% of options in private technology companies go unexercised.
Enter Liquid Stock. The investment firm is backed by Goldman Sachs Asset Management, Morgan Stanley AIP and Coller Capital and is liquidity provider for option holders and stockholders of private companies looking for tax efficient solutions to fund stock option exercise or generate liquidity in lieu of a sale. Robert Pitti, founding partner at Liquid Stock, spoke with Traders Magazine Editor John D’Antona Jr. to discuss the stock options market, how it has weathered the COVID pandemic and the value a firm like Liquid Stock brings.
TRADERS MAGAZINE: How has the equity options market been reacting during this crisis? How can we expect to see it react moving ahead? What has happened and what more can happen?
Robert Pitti: Equity option grants represent a large part of compensation in private technology companies and they usually have a ten-year expiration period. However, when an option holder leaves a company, either voluntarily or involuntarily, their options typically expire in 90 days. Many option holders do not have the capital or resources to exercise their options or do not want to risk other assets, so they leave their hard-earned equity on the table.
Private company layoffs are increasing in response to the economic uncertainty tied to the current crisis. This means more employees are faced with losing their equity unless they can come up with significant amounts of cash in a short period of time. The problem only gets worse as the pace of layoffs increases.
When the environment begins to stabilize and the layoffs slow down, more employees will conclude that they’d rather be shareholders as opposed to option holders. Having seen friends or colleagues lose their jobs and their equity, option holders will be looking to exercise their options as early as possible so they can own their shares since these exercised shares are portable (cannot be forfeited). Companies have plenty of incentive to help employees exercise their options, which can soften the blow of layoffs, promote an employee friendly culture and generate valuable working capital for the company.
Liquidity is at a premium in today’s market environment. Employees who already own their shares are increasingly looking for ways generate liquidity to diversify, reduce risk and meet living expenses. In the recent past, private company shareholders may have been able to sell a portion of their private company shares to a secondary buyer or, in some cases, back to the company. The current environment makes it more challenging to sell private shares since it’s difficult for buyers and sellers to agree on price. Even if there are willing buyers at a price, selling at a low price today may not be appealing if shareholders believe their company’s value will rebound.
TM: What does it mean for those compensated in options? Are they in serious trouble or can they make a killing? Is there an alternative?
Pitti: What it shows, above all, is the desire for flexibility. In the past, liquidity solutions for those requiring capital were typically offered as either a loan or as part of a direct tender (sale) offer. Each of these traditional but inflexible paths to liquidity come with disadvantages: recourse loans have fixed maturities and put personal collateral assets at risk, while a tender offer naturally means you are no longer availed of the upside in the value of the company. Both of these choices may also have adverse tax consequences that greatly reduces the end value of the transaction.
Instead, Liquid Stock provides a tax efficient, non-recourse financing alternative that is secured by the exercised shares, themselves. Liquid Stock financing is only paid back if there is a future IPO or other company liquidity event. It also takes into account the risk of company failure and provides the capital necessary to cover the cost of exercise and the related taxes. So, unlike the traditional choices, our financing is designed so that our interests are always aligned with our clients’.
TM: What can tech companies do to mitigate current market forces?
Pitti: We face a tough situation right now as companies and investors adjust to the new environment. In this uncertain period, companies can help their current (and former) employees by offering a non-recourse financing plan as a solution. As a matter of corporate responsibility, they should aim to ease the pain associated with an involuntary termination and the anxiety of being an option holder by helping option holders become shareholders. It’s about finding the right path to liquidity that does not involve selling stock today at a discount, or otherwise reducing an employee’s equity stake in the company.
TM: What are the specific benefits of Liquid Stock’s financing structure?
Pitti: Liquid Stock provides a unique solution that provides capital to a private company shareholder to finance their option exercise or generate liquidity in lieu of a secondary sale. The private company shares act as collateral for the transaction and the transaction is only repaid upon a future liquidity event such as an IPO.
Importantly, this type of transaction is considered non-recourse to the shareholder, so it is secured only by the private collateral shares and a shareholder does not risk personal assets. If, for example, the company fails and the collateral shares become worthless, a shareholder can surrender the worthless shares in full repayment with no further obligation. In other words, the risk of company failure is transferred to Liquid Stock. This is an attractive alternative for option holders who want, or need, to exercise their options but do not have the necessary capital. The option holder receives the capital to exercise their options and pay the associated taxes with limited personal risk. Furthermore, the cost of capital is very reasonable, especially when the alternative is to forfeit hard-earned equity.
With Liquid Stock, startup shareholders also have a path to liquidity when they cannot find a buyer at an attractive price, or any price at all. Similar to option exercise, shareholders receive cash on a tax efficient, non-recourse basis using private company shares as collateral. The result is that they can get liquidity today and hold onto more of their equity upside.
TM: What makes Liquid Stock a leader in the field?
Pitti: Everything we do starts and ends with providing the right solution for companies, option holders and shareholders, all built around our core values of integrity and transparency. It starts with how we designed and built the Liquid solution from the risks we assume as the capital provider to the details around optimizing taxes of option holders and shareholders.
Our nearly two decades of experience differentiates us from competitors. Because we have evolved our model through periods of volatility and market downturns, like the one we face today, we are better able to understand the unique problems faced by option holders and shareholders in today’s private companies. We appreciate that these are consequential financial decisions and work hard to help our clients make the right decision, even if it means suggesting a different path.
Over the years we have developed an innovative solution and a streamlined process, elements of which are reflective of our experience, and compared to other alternatives our transactions tax efficient and structured to comply with corporate charter documents.
Finally, Liquid Stock is a well-funded investment group with strong institutional backing, which is reflected in our service level. When individuals or companies come to Liquid Stock, they are dealing directly with decision makers and one of our founding partners is involved every step of the way.
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