It’s good to be back writing again after a few busy weeks. Last week, I attended an event hosted by our friends at Allocate where we got to meet a lot of top-tier VCs down on Sand Hill. Listening to these GPs speak about the last few years and where we currently stand was a fascinating insight into the VC world, the power law dynamics, and the state of venture. Needless to say, I learned a lot.
As an intro to today’s topic, I wanted to share a quote from Samir Kaul who is a Founding General Partner at Khosla Ventures:
“Every fund overpaid in 2021, but the good funds have done less bad than the others.”
It’s now an assumed fact that nearly every company that raised money in late 2020 to early 2022 is likely overvalued when you apply today’s multiples due to the decline in the public markets. Even the best companies out there are not immune to today’s changing market environment.
A couple weeks ago, Stripe announced a funding round where they raised $7B at a $50B pre-money valuation. But, they also said they didn’t need additional operating capital. So why did they raise a record setting Series “I” round? To ensure that employees were able to generate liquidity and pay taxes. Let’s dive in.
📆 Stripe equity has an expiration date
Stripe was born in 2010 out of Y Combinator. At 13 years old, they are one of the older VC backed startups and, despite many rumors, have yet to commit to going public. This has created a liquidity problem for employees. And though Stripe has held generous tender offers over the years (more on this below), it’s probably fair to say that a lot of employees are looking forward to an IPO, so they can finally realize the full value of their equity.
Staying private for so long doesn’t just push out the potential for liquidity — it could actually remove the possibility due to expiring equity grants. Stock option grants have a standard 10-year expiration date, unless they’re exercised within that time. This isn’t necessarily a new issue, and it’s something we’ve helped employees at companies like Airbnb and Palantir with in the past.
💸 But not all options are created equal
Stripe has another issue, though. Like many highly valued companies, they switched to granting Restricted Stock Units (RSUs) over ISOs or NSOs because exercising the latter would be much too expensive for employees (due to the high valuation).
Companies like Stripe also issue RSUs with a “double-trigger” vesting schedule. This means that they vest over a set time period, just like any stock options (e.g. you get 25% after the first year, with the rest vesting monthly for the next three years). But these RSUs also come with a second trigger that’s directly tied to a public listing. Meaning that, technically, none of those options vest until the company is public.
This is generally a good thing. If there was no double-trigger vesting, employees would get taxed at the time of vesting, yet they’d likely have no way to sell those shares to cover the cost. An employee who vests $200K worth of RSUs could be taxed on that amount at a tax rate of more than 50%!
So why is this suddenly an issue?
As I mentioned, Stripe has held regular tender offers over the years to help employees get some immediate liquidity. But RSUs present a problem: Because they’re not vested, employees can’t participate in a tender offer. Only those that have stock options (ISOs or NSOs) they can exercise or those that have already exercised are able to.
Of course, that’s not fair, and it’s what Stripe set out to fix in order to do what’s right for their employees.
🚣 The unique Collison solution (and a boatload of cash)
Stripe had a couple avenues to solve this. The most obvious is that they could go public. But this market environment is not kind to growth companies like (and even) Stripe. Plus no one, especially the Collison brothers, gets excited about a forced IPO.
So, they opted for solution number two. And it’s not one that many companies could pull off: Raise a boatload of money to vest those RSUs today, then run a tender offer for employees to cash out their shares completely.
Smooth sailing, right? Almost. Here’s how it will probably work:
Stripe will give (or force) their employees with RSUs to forgo the second trigger and immediately vest their options. As I said above, this will create a large tax liability.
Let’s take an example of a Stripe employee with 10K RSUs. The Series “I” preferred price is $20.13, but let’s use $20 to make it simpler.
The Stripe employee will have to pay taxes on ordinary income of $200,000 (10K RSUs x $20). A California resident (which many employees are) may pay up to 53.65% in taxes, but let’s use an effective tax rate of 45%. On top of that $200K, that employee may also have a tax bill of $90,000.
Most don’t have that kind of cash laying around in their bank accounts, so Stripe will offer what’s called a net exercise or a cashless exercise.
This means that Stripe will pay that $90,000 on behalf of the employee by taking back some shares in exchange. In this example, Stripe will take back 4,500 shares ($90,000 / $20 per share) and give the employee a net 5,500 shares.
Those are shares the employee will now own, and can sell in the upcoming tender offer — all without any cash leaving their bank account.
I don’t know the exact numbers, but I’d imagine a good chunk of the $7B raised will go towards paying the tax bill for those employees vesting those RSUs. It’s a great solution that likely only Stripe could pull off as not many can raise that amount of money in this market environment.
📈 How will this impact other late-stage startups?
I wouldn’t be surprised if we see more tender offers in the near-term so employees can access liquidity (Elon Musk announced Twitter would hold them every six months, similar to what Space X already does), but most companies can't do anything on the scale of what Stripe is doing to help all employees.
Instead, they'll have to take the route that Stripe didn’t (but likely will eventually): Go public. There’s a growing backlog of companies that are waiting in the wings. A few dozen IPOs have already been publicly filed, with significantly more that have likely filed confidentially. Many are names you’d expect — Databricks, Instacart, Fanatics, Reddit, GoPuff, Snyk, Outreach, Attentive, and more. But there are many more solid companies that are also quietly waiting.
For now, the IPO window remains closed but expect that some of these companies will test the waters in 2023. Depending on how those initial ones go, many more could follow soon after, or delay further into 2024. The problem for those that continue to wait is that they’ll likely need to raise additional funding this year.
The good news — and hopefully music to many of your ears — is that tender offers could accompany those funding rounds. The not-so-great news? They’ll probably be down rounds. And, those with RSUs may not be able to participate (because of those tax costs related to removing the double-trigger).
One thing I haven’t mentioned yet is that Stripe’s $7B came at a cost. They were last valued at $95B but it was slashed to $50B to close their Series “I” (less than the $60B they were hoping for).
Look, a $50B valuation is still nothing to sneeze at. But cutting your valuation doesn’t come without consequences for employees as I laid out in this case study. That’s why it’s never too late — or too early — to start planning for an upcoming liquidity event, whether it’s an IPO, a tender, or an M&A. You may even want to explore a secondary sale if you need cash today.
There’s no wrong or right answer, but it’s important to know your options and plan accordingly. If you do want help, feel free to set up a call with one of our financial advisors.
Here’s my final note: We’re living in a tech downturn right now. Coming to the realization that the valuations of the last few years aren’t coming back may be tough. But the reality is that most startups don’t even get to where Stripe or other late-stage companies are still at.
Aside from having FOMO at selling for $80 a share, I’d consider myself incredibly lucky to be a Stripe employee faced with the decision to sell or hold right now. Look out for a future newsletter where we discuss how to best face that discussion.
Thoughts? Comments? Something else you want to see me write about? Feel free to reply our hit me up on Twitter: @viejep.
Things we’re digging:
- 🤝 Giving back made simple. I’m very excited that we just announced our partnership with Daffy. They’re building something great, and I’m glad that we can help our clients give back to the causes they truly care about. Their CEO and co-founder Adam Nash contributed a newsletter about the benefits of donor-advised last year.
- 💰 Liquidity FTW. Despite the recent hard times in tech, there’s light at the end of the tunnel. IPOs aren’t the only way out. Besides an uptick in tenders, more M&As could also be on the horizon. That’s why right now is a good time to start planning (again, we’re happy to help).
- 🤖 AI or nay? This petition to pause AI developments has been signed by some big names. What do you think??