Loans could burn start-up workers in downturn
SAN FRANCISCO — Last year Bolt Financial, a payments startup, launched a new program for its employees. They owned stock options in the company, some of which were worth millions of dollars on paper, but couldn’t touch that money until Bolt was sold or made public. So Bolt began giving them loans — some running into the hundreds of thousands of dollars — against the value of their shares.
In May, Bolt laid off 200 workers. This triggered a 90-day period for those who had taken out the loans to repay the money. The company tried to help them find refund options, said a person with knowledge of the situation who spoke anonymously because the person was not authorized to speak publicly.
Bolt’s program was the most extreme example of a burgeoning ecosystem of loans for workers at private tech start-ups. In recent years, companies such as Quid and Secfi have sprung up to offer loans or other forms of financing to start-up employees, using the value of their private company’s shares as a kind of collateral. These providers estimate that employees of startups around the world have at least $1 trillion in equity to lend.
But as the start-up economy deflates, rocked by economic uncertainty, soaring inflation and rising interest rates, Bolt’s situation serves as a warning about the precariousness of such loans. While most are structured to be forgiven if a startup fails, employees could still face a tax bill because loan forgiveness is treated as taxable income. And in situations like Bolt’s, loans can be difficult to repay on short notice.
“No one has thought about what happens when things go wrong,” said Rick Heitzmann, investor at FirstMark Capital. “Everyone thinks only of advantage.”
The proliferation of such loans has sparked a debate in Silicon Valley. Proponents said the loans were necessary for employees to participate in the technology’s wealth-building engine. But critics said the loans created unnecessary risk in an already risky industry and brought to mind the dot-com era of the early 2000s, when many tech workers were badly burned by loans tied to their stock- options.
Ted Wang, a former startup lawyer and investor at Cowboy Ventures, was so alarmed by the loans that he published a 2014 blog post, “Playing With Fire,” advising most people against them. Wang said he gets a new round of calls about loans every time the market heats up and he always feels pressured to explain the risks.
“I saw it go wrong, very wrong,” he wrote in his blog post.
Start-up loans stem from how workers are typically paid. As part of their compensation, most employees of private technology companies receive stock options. Options must eventually be exercised, or purchased at a fixed price, to hold the shares. Once someone owns the shares, they usually can’t cash them in until the startup goes public or is sold.
This is where loans and other financing options come in. Seed shares are used as collateral for these cash advances. The loan structure varies, but most providers charge interest and take a percentage of the worker’s stock when the business sells or goes public. Some are structured as contracts or investments. Unlike the loans offered by Bolt, most are known as “non-recourse” loans, meaning employees aren’t required to repay them if their stock loses value.
This lending industry has exploded in recent years. Many providers were created in the mid-2010s as hot start-ups like Uber and Airbnb postponed initial public offerings of shares for as long as they could, reaching private market valuations in the tens of billions. of dollars.
This meant that many of their workers were bound in “golden handcuffs”, unable to quit their jobs because their stock options had become so valuable they could not afford to pay the taxes, based on the current market value, to exercise them. Others have grown tired of sitting on options waiting for their business to go public.
The loans gave the start-up employees cash to use in the meantime, including money to cover the costs of purchasing their stock options. Even so, many tech workers still don’t understand the intricacies of equity compensation.
“We work with super-smart computer science graduates from Stanford, but no one explains to them,” said Oren Barzilai, chief executive of Equitybee, a site that helps start-ups find investors for their shares.
Secfi, a provider of financing and other services, has now issued $700 million in cash financing to startup workers since opening in 2017. Quid has issued hundreds of millions of loans and other financing to hundreds of people since 2016. Its latest $320 million fund is backed by institutions including Oaktree Capital Management, and it charges those who take loans origination fees and interest.
So far, less than 2% of Quid’s loans have been underwater, meaning the market value of the stock has fallen below that of the loan, said Josh Berman, one of the founders of Quid. the society. Secfi said 35% of its loans and funding had been fully repaid and its loss rate was 2-3%.
But Frederik Mijnhardt, chief executive of Secfi, predicted the next six to 12 months could be tough for tech workers if their stock options lost value in a downturn, but they took out loans at a higher value.
“Employees could face a settling of scores,” he said.
These loans have become more popular in recent years, said JT Forbus, an accountant at Bogdan & Frasco who works with start-up employees. One of the main reasons is that traditional banks do not lend from the equity of a start-up. “There are too many risks,” he said.
Startup employees pay $60 billion a year to exercise their stock options, Equitybee estimates. For various reasons, including the impossibility of affording them, more than half of the options issued are never exercised, which means that the workers give up part of their remuneration.
Mr. Forbus said he had to carefully explain the terms of these agreements to his clients. “The contracts are very difficult to understand and they don’t really play on the math,” he said.
Some start-up workers regret taking out loans. Grant Lee, 39, spent five years working at software start-up Optimizely, racking up stock options worth millions. When he left the company in 2018, he had the choice of buying his options or giving them up. He decided to exercise them by taking out a $400,000 loan to help pay the costs and taxes.
In 2020, Optimizely was acquired by Episerver, a Swedish software company, for less than its last private valuation of $1.1 billion. This meant that stock options held by employees with the highest valuation were worth less. For Mr. Lee, the value of his Optimizely stock fell below that of the loan he had taken out. Although his loan was forgiven, he still owed about $15,000 in taxes, as the loan cancellation is considered taxable income.
“I received nothing, and on top of that I had to pay taxes for having nothing,” he said.
Other companies use the loans to give their workers more flexibility. In May, Envoy, a San Francisco startup that makes work software, used Quid to offer non-recourse loans to dozens of its employees so they could then get cash. Envoy, which was recently valued at $1.4 billion, hasn’t encouraged or discouraged people from taking out loans, said Larry Gadea, the chief executive.
“If people believe in the business and want to double down and see how much better they can do, that’s a great option,” he said.
During downturns, loan terms can become more onerous. The IPO market is frozen, pushing potential gains farther into the future, and the depressed stock market means the shares of private start-ups are likely worth less than they were during good times, in especially over the past two years.
Quid is adding more underwriters to help find the appropriate value for the seed stock it lends to. “We are more conservative than in the past,” Berman said.
Bolt appears to be a rarity in that it offered high-risk personal recourse loans to all of its employees. Ryan Breslow, the founder of Bolt, announced the program with a congratulations flourish on twitter in February, writing that it showed that “we simply care more about our employees than most.”
The company’s program was intended to help employees afford to exercise their shares and reduce taxes, he said.
Bolt declined to comment on the number of laid-off employees who had been affected by loan repayments. It offered employees the choice of returning their start-up shares to the company to repay their loans. Business Insider reported earlier on the offer.
Mr Breslow, who resigned as chief executive of Bolt in February, did not respond to a request for comment on the layoffs and loans.
In recent months, he helped found Prysm, a provider of non-recourse loans for seed capital. In pitch materials sent to investors and viewed by The New York Times, Prysm, which did not respond to a request for comment, announced that Mr. Breslow was its first client. Borrowing against the value of his shares in Bolt, according to the presentation, Mr. Breslow took out a $100 million loan.