It’s well documented that high profile start-ups have voraciously gobbled-up venture capital money over the past several years. These unicorns and decacorns have spurned conventional wisdom and boldly proclaimed that they need not be bothered by the distraction of going public. However, what hasn’t been discussed so openly is how staying private impacts the rank-and-file tech employee. Here’s what you should know.
A longer IPO timeline can trap employees
Stock vesting doesn’t happen overnight and tech companies are smart enough to make that carrot large enough to keep you around. While there’s nothing inherently wrong with this (in fact we like to see clients benefiting from generous stock grants) the discussion becomes admittedly grey if leadership has no intention of providing near term liquidity for your options. And the reality is, tech companies are waiting much longer to go public these days – according to according to statistics maintained by Jay Ritter, a professor of finance at the University of Florida, the typical tech company hitting the markets in 2014 was 11 years old, compared with a median age of seven years for tech IPOs since 1980. This can put tech employees in a tough spot as most stock plans require participants to exercise shares shortly after taking another job. And exercising lucrative stock grants requires liquidity to both purchase shares and pay the potentially costly AMT tax ramifications. As such, stock options can have the unexpected consequence of limiting your career mobility.
Abstaining from public markets makes selling vested stock challenging
Unless companies go public there really isn’t a transparent way of diversifying. We saw secondary exchanges take off prior to the Facebook IPO and this space continues to grow and evolve. Most recently we’ve seen new players emerge that focus on providing the liquidity needed by tech employees to exercise shares (discussed above). Essentially, these firms are exchanging loans for promised shares in the future. And more companies are simply taking matters into their own hands – Uber has been known to purchase stock from employees at a discount and Palantir has an executive that acts as a broker. However, the dilemma with all of these options is that they make for a complicated risk-reward analysis. Without a reliable way to value your shares it can be difficult to determine if selling (or exchanging future ownership of) private shares is a better alternative to waiting for an IPO or acquisition. But with more unicorns than ever before, tech employees are simply unable to sit idly – there’s too much wealth at stake.
More venture capital funding creates dilution and potentially inflated valuations
There’s no denying that it’s exciting when your company gets funded by a high profile venture firm. However, after it all settles in, it’s important to take a deep breath and think about how the funding might impact you as an employee. One of the first things employees should think of is dilution, or the process of having your ownership reduced in order to finance the latest round of funding. Venture capitalists would say that dilution is worthwhile when the value of your company goes up enough to offset your reduction in ownership. And this makes logical sense, but what about in our current market environment where inflated valuations have led unicorns like Good Technology to sell at a deep discount or Square to price below its private valuation after going public? It’s possible that these are indications that venture firms are simply becoming too big. Despite decreases in total industry fundraising, the average size of a venture firm today is actually just shy of the dot-com era (and the median is probably much larger). And with a limited supply of investment opportunities it’s no surprise that we’re seeing firms write bigger checks. The problem is, this type of cycle inevitably causes valuations to spike, especially for “hot” companies. And at some point when valuations exceed what the public markets will support a correction occurs. This is what tech employees need to be aware of and include in their risk-reward analysis (discussed above).
At Schmidt Financial Group we fully appreciate the unique challenges of working in the tech sector – we’ve experienced it ourselves and in working with our tech client base for over 20 years. Having most of your wealth tied to employer stock is complex and requires specialized planning. Come talk to us if you’d like to learn more about how you can successfully mitigate single stock concentration risk in the context of a holistic financial plan.