How to Exercise Options You Can’t Afford

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Many employees of privately held companies are forced to leave potentially valuable shares on the table because they can’t afford to exercise their stock options. Many investors want to buy into promising companies while they are still privately owned, getting the best possible price. Funding stock options may solve both problems at the same time.

Let’s take a closer look.

Funding Stock Options: How it Works

Many private companies offer stock options to employees. These offers are designed to add to worker compensation and attract quality employees without costing the company badly needed cash.

A stock option is not a stock giveaway. The employee has to exercise the option, meaning they buy the stock. They often get a preferential price, but they still have to pay. If the employee doesn’t have the cash to exercise the option, it will eventually expire. The shares are left on the table and the employee is left out of any future gains.

Several companies specialize in providing financing for employees that want to exercise a stock option. They do this in one of two ways:

  1. Linking employees with investors. Some companies broker a transaction between the employee and an investor who wants exposure to the company. The investor pays the cost of exercising the option and takes a percentage of the proceeds when the shares become liquid.
  2. Using their own resources. Some companies engaged in funding stock options are structured as capital funds. They use their own money to finance the option exercise and take a percentage of the shares as payment when the shares become liquid. Many of these companies will also provide financing to employees who own shares.

If you’re an employee who wants to exercise an option but can’t afford it, or you want to convert shares you hold to cash, you can deal with either type.

If you’re an investor who wants to fund stock options as a tool to buy private company shares, you’ll need to work with a company that links investors to employees.

The Benefits for Employees

Stock options sound like a great idea. You do your job and get your salary, and on top of that, you get company stock. If the company succeeds, that could be worth a lot of money. Stock options allowed many early employees of high-profile companies to become millionaires.

The only problem is that exercising those stock options costs money. It may be money that you don’t have, especially if you’re paying off student loans and other debts. It hurts to see your stock options expire because you couldn’t afford them, especially if they were part of the reason why you took the job in the first place.

EquityBee, which is engaged in funding stock options, estimates that around $60 billion worth of stock options are made available every year, and around 55% of that value is left on the table by employees that do not exercise options.

Finding an investor to fund the exercise of your options is an ideal solution. The investor will get part of any potential proceeds, but they also assume most of the risk. You get the shares and a part of what they earn (if anything) without putting up cash.

The Benefits for Investors

Buying private company shares allows an investor to take a position in a company before the share value is bid up by private trading. Traditionally this option has only been open to institutional investors or high-net-worth individuals who participate in venture capital funding rounds.

Private companies issue shares to institutional investors as a way of raising capital. They also offer shares, either directly or as stock options, to employees as part of their compensation.

It is difficult to buy shares that were issued to employees. These transactions typically have to be approved by the company, and companies aren’t always willing.

Funding stock options requires no company approval because the shares are simply being purchased by the employee as offered by the company. Financiers don’t buy the shares, they buy the right to a portion of the proceeds when the shares are sold.

The Companies that Make It Happen

These companies provide funding for exercising stock options, essentially as a loan. If the company is acquired or goes public, a specified number of shares goes to the investor who funded the loan. If the company does not provide an exit point or if the shares sell for less than the option’s strike price, the employee has no liability.

These are some of the companies engaged in funding stock options.

Equitybee

Equitybee specializes in funding stock options for employees of high-growth VC-backed startups. They have worked with over 1700 employees across multiple industries, many of whom have experienced successful exits. 

Most companies on the platform are backed by prominent VC or private equity firms, have raised at least $30 million, and have completed at least one funding round.

Equitybee links private investors to employees looking for funding to exercise stock options and is a good choice if you are looking to use the option funding process to acquire stock. Investors need to pass an accreditation process. This is required by the SEC, as the securities involved are not registered.


SecFi

SecFi provides a range of services involving equity planning for startups and private companies and their employees. Aside from funding stock options, these services include equity planning, wealth management, tax planning, and various forms of financing.

SecFi provides financing for employees who want to exercise their options. The financing package covers all costs, including taxes. Employees can take this financing in the form of a loan with monthly payments or pay when the company exits.

SecFi currently serves around 30,000 employees and has provided roughly $700 million in financing for funding stock options.

The SecFi website is heavily employee-oriented and provides little guidance for investors interested in buying shares. Their investment branch, SecFi Capital, advertises access to “high-growth startups on track to go public”, but you’ll need to contact them for details.


LiquidStock

LiquidStock advances money to employees who want to exercise their options. Contracts are settled when there is a “liquidity event”, like an IPO, an acquisition, or any other event that makes the shares marketable. A fixed percentage of the shares are transferred to LiquidStock when there is a liquidity event.

If there is no liquidity event or the price is below the option strike price, LiquidStock takes the loss. You don’t have to cover the difference.

If you have exercised your options and are looking to convert the shares into cash, LiquidStock also lends money to private company shareholders with shares as collateral. You pay when there’s a liquidity event.

LiquidStock’s website does not discuss opportunities for investors to acquire shares.


ESO Fund

ESO Fund has been operating since 2012 and describes itself as “the oldest and largest employee equity company in the world”. They have handled more than 1000 transactions at over 500 companies.

ESO will fund option exercises and the associated excise taxes. Once your application is approved funding is available in as little as 24 hours. When the stock becomes liquid you’ll repay the initial investment plus a percentage of the stock.

ESO Fund also has liquidity solutions for employees who have already exercised options or received Restricted Stock Units (RSUs).

Like LiquidStock, ESO Fund works with their own capital and does not solicit outside investors.


Quid Capital Fund

Quid is designed to help employees at startups and private companies exercise their options or convert their shares to liquid assets. The company has worked with shareholders at a long list of companies, including Air BnB, Uber, Lyft, Palantir, Robinhood, Discord, and many others.

The model is straightforward. If you have options that you can’t afford to exercise, contact the Company. If they are willing to make a deal, they will advance the funds for the exercise and take repayment when the shares become liquid.

Quid will also provide liquidity options for employees who hold shares, also taking repayment when the shares become liquid. All risk is carried by the Company: if the shares don’t become liquid you have no obligations.


If You’re Buying

If you’re planning to fund stock option exercise as a way of buying private company stock, you should be familiar with the risks of pre-IPO investing. The company might not go public and there may never be a market for the shares. Even if the company goes public the shares may not increase in value.

You’ll have a limited range of options as a buyer: many of the companies listed here are not open to private investors. There are other ways to buy pre-IPO stock, but in most cases, you will have to meet the SEC’s accredited investor criteria.

There is never any assurance that a given platform will have available shares or option finance opportunities for any given company.

If You’re Selling

If you’re an employee with options you can’t afford to exercise, these companies can provide a solution. As with any financial deal, though, you should do your homework first.

The balance between the interests of the employee, the financier, and the broker (if any) is tricky and needs to be structured as a win-win-win agreement. All parties involved have to fully understand the terms and their obligations.

These arrangements remove all risk from the employee exercising the option. If the shares fall in value or don’t become liquid at all, the company or the investor eats the loss. That works for the employee, but you can also expect to pay a considerable price for a no-risk transaction.

Paying that price is probably reasonable if the alternative is letting your options expire: if that happens you gain nothing, and something is always better than nothing. If you do have other potential ways to exercise the options, consider using those first.

If you’re considering making a deal for shares you already own (a service many of these companies also offer) you’ll have to analyze the situation carefully. You will give up a substantial number of shares (remember, it’s a no-risk deal for you, and those don’t come free). If an IPO or other liquidity event is likely at any time soon and you have confidence in the future, you might be better off keeping those shares for yourself!



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