Pre-IPO: Financing/Exchange/Selling
Pre-Read: Key Questions This Article Answers
Should I use borrow money to exercise my options? When it is a good idea? A bad idea?
What is a pre-IPO exchange fund, and why is it something I might want to consider using?
Can I get financing on my RSUs if my company is still private/pre-IPO?
Can I sell shares of my private/pre-IPO company? How?
Why Do Pre-IPO Financing/Exchange/Selling Companies Exist?
Over the last 10 years, a growing number of VC-backed companies have opted to stay private for significantly longer periods of time. As such, it's created some unique challenges for their employees who have accrued significant wealth via their company equity. Relative to the past--where a liquidity event would typically make it possible for the individual to sell/diversify-- they instead will have the vast majority of their wealth (via private company stock/options) "trapped" due to the illiquid nature of Pre-IPO company stock. This can create challenges across a number of vectors:
"Exercise or forfeit" scenario when leaving company. If an individual's vested options do not have a PTEP, they will need to exercise their vested options or let them expire when they leave. But an individual may not have the funds to exercise, or desire to risk a large portion of their capital to exercise.
Diversification. If the company has grown significantly since an individual joined, then it is likely that a significant amount of that individuals wealth is in company stock. Even if they heartily believe in the company, data strongly suggests that they should diversify (if they can) to reduce risk and help preserve value. This can be via either (i) the sale of company stock on a private exchange or through a broker (if allowed), or (ii) via a Pre-IPO exchange fund.
Need for funds. An individual desires to utilize a portion of their private company wealth/value for other life needs, such as purchasing a home. They have a significant net worth (based on the value in their company), but this value is illiquid and unavailable for use.
Pre-IPO Financing/Exchange Companies Help Fill the Need
In the spirit of Silicon Valley, a problem existed and companies were created to solve it. As of 2023, there are several third-party companies that provide services to help individuals sell, exchange, and/or borrow against pre-IPO stock holdings. They can generally be categorized into one of four groups:
Option exercise financing. These firms provide loans to finance the exercise/purchase of stock options at a Pre-IPO company (typically inclusive of any associated tax bill). Generally, the loan is only secured by your company equity (i.e. if your company fails you owe nothing), but there can be some "gotchas", and they tend to charge a significant amount of interest + take a portion of your company equity when it does do well.
RSU financing. RSU financing is a bit different than option financing. To appropriately secure the loan against an RSU, company approval is typically required (i.e. you will likely know if your company has a program for this). Additionally, unlike option financing, RSU financing terms are generally much more attractive. Most times, RSU financing is utilized by individuals who would like to access some of their RSU-based wealth for other purposes (e.g. buying a home).
Private market exchanges and brokers. Pre-IPO exchanges and brokers help facilitate the sale of Pre-IPO shares to other investors. Sales require the transfer of ownership, and as such, your company needs to approve of this (many do; and many don't). But if your company does, it is a way for existing and former employees to sell and diversify.
Pre-IPO exchange funds. Exchange funds (not to be confused with an "exchange traded fund" or ETF) are unique vehicles. In general, they allow you to swap/exchange your holding in a single company for partial ownership (equal dollar value) in a Limited Partnership. This transaction is tax-free (when rules are followed), but facilitates material diversification. For example, 20 individuals each own $500k of stock in a different company all contribute to an Exchange fund. Each thereafter has 5% ownership of the LP fund (which owns 20 different companies, and has a value of $10 million).
Key Decision: Should You Use Any of These?
Determining whether a Financing/Exchange/Selling company is something you should consider using depends on a number of factors; primarily (1) your personal financial situation, (2) your work situation; (3) your belief in your company, and (4) if your company authorizes the use of some of these services. But to try to be helpful, some general thoughts are:
Option Exercise Financing
While still actively employed. In most circumstances, we do not recommend financing the purchase of options while you are still an active employee and plan to continue to be one. It is circumstance and terms specific, but most option financing companies have large built-in fees, imputed interest rates, and claim material portions of your equity. And given that -> you'd be financially better off waiting (i.e. not exercising) and then selling when a liquidity event occurs.
When leaving a company ("exercise or forfeit" scenario). If you are leaving your company and need to exercise vested options or lose them, financing the option exercise can make sense. Especially if you don't have the cash and/or don't believe strongly in future upside, financing the purchase allows you to maintain upside potential/value from your vested options, with limited downside risk.
There may be a cost to you if your company fails. Option financing loans are marketed as non-recourse -- but be aware that if the stock ends up worth little or nothing, the company will cancel/"forgive" the loan -> and that is a taxable event to you (i.e. if you borrow $100k to finance options and the company fails; the $100k forgiven debt becomes ordinary income to you, and you'll owe taxes on it)
RSU Financing
This is case-by-case. The loans typically carry higher interest rates (12-18%), but depending on your level of wealth, financial liquidity, and use case for cash, those types of interest rates (collateralized against your stock/RSUs) may be something worth considering. As noted above, a loan collateralized against your RSUs likely requires your company's permission (i.e. a known and internally announced program will likely exist).
Private Market Exchanges and Brokers
This is a case-by-case. Reducing concentration risk (by selling) is usually beneficial, but the pricing needs to make sense. On secondary markets, pricing can be attractive at times, and unattractive other times. Many times, your company also needs to allow this transaction to occur (i.e. this path may not be available to you).
Pre-IPO Exchange Fund
Exchange funds for Pre-IPO company stock is relatively new. Similar to a private market sale, using a pre-IPO exchange fund will help reduce your concentration risk (a strong plus), but the pricing the fund offers you to make the exchange needs to make sense. Additionally, your company also needs to allow this transaction to occur (i.e. this path may not be available to you).
Other key points worth noting/considering include (1) participating in an exchange fund does not trigger a sale/tax bill (it's deferred until you sell out of the LP fund position), and (2) your LP fund position will give you exposure to a portfolio that is more like a VC fund (given the portfolio is comprised of a number of Pre-IPO companies).
Most financing, exchanges, and funds only work with larger-sized Pre-IPO companies. If your company is valued at less than $500m (or even $1 billion), you may find it difficult to find any platform that is able and willing to do business with you.
Important Considerations & Decisioning Tools
If exploring liquidity or monetization options before an IPO, two key decisions are:
(1) Should You Utilize One of These Specialty Platforms?
Analyze to see if the economics and terms make sense for your situation vs. simply holding.
Consider your personal liquidity needs, concentration risk, and company outlook.
In some cases the benefits clearly outweigh alternatives; in others, the costs are too high.
(2) If Moving Forward, Which Provider Should You Work With?
Fees, term, and structure can and do vary by provider. It's recommended that you speak with multiple companies.
Understand the tax implications fully in all scenarios.
Making informed decisions requires thorough due diligence on providers and careful analysis of the costs vs. benefits for your personal financial situation.
Tools & Decisioning Frameworks
Given the complexities and long-term implications of these decisions, leveraging tools and frameworks is recommended.
Scenario modeling. Build out projected scenarios on spreadsheets modeling different approaches. Key variables include cost of financing (if applicable), stock appreciation/depreciation, and taxes.
Tax analysis. Work with a tax professional to forecast the tax implications of each scenario. Key factors are typically ordinary income vs. capital gains rates and AMT.
These projections allow you to quantify potential upside vs. the costs under different conditions. While uncertainty always exists, tools enable more data-driven decisions vs. gut feel and rules-of-thumb. Thoughtfully modeling the trade-offs and tax optimization opportunities can lead to more informed choices on if and how to access Pre-IPO liquidity.
Popular Financing/Exchange/Selling Companies
Option Exercise Financing
RSU Financing
Private Market Exchanges and Brokers
Note: a number of talented independent brokers also exist
Pre-IPO Exchange Funds
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