September 15, 2015 | Blog

Stock Options and the New Silicon Valley

For decades, a key part of the success of Silicon Valley companies has been employee ownership. Granting stock options attracted the most talented employees and motivated them to work tirelessly in pursuit of an IPO enabled cash-out. Now though, private companies are staying private much longer and so the appeal of stock options is diminishing. Because of the recent market volatility, more IPOs are likely to be delayed, further dimming the hopes of employees looking for public market liquidity . Faced with that reality, what are smart private companies doing to reestablish the lure of equity ownership?

The Valley’s Secret to Success

Traditionally, a Silicon Valley start-up would allocate roughly 20% of its stock to its employee option pool. Key employees, through option grants, would own a recognizable percentage of the company. The employees’ objective was to build the company and get to an IPO as quickly as possible. In 2000, the average time from formation to an IPO was just six years. At the IPO, options would become liquid and the sale of the underlying shares could create real wealth for employees. To make that happen, employees were completely invested in the company’s success and gave their all to get the company across that IPO finish line.

By contrast, public companies could only offer a small number of options on shares that would appreciate minimally. Compensation was therefore almost entirely focused on salary and bonuses. Consequently, those seeking stability in the form of a solid 401(K) and good health insurance went to work for a big public company like Microsoft. Those looking to create wealth and build something exciting went to work for a disruptive private start-up like Dropbox.

Over the years, Silicon Valley start-ups seem to have consistently outperformed the big public companies. Their success can be attributed to multiple factors, but it’s clear the incentives and culture of employee ownership and the kind of people they attract are a big part of the reason why.

Then Options Lose Their Appeal

Over the past decade, the world changed for Silicon Valley start-ups. For several reasons, start-ups started staying private much longer. Today, the average company is 11 years old when it goes public – not six. Compounding this trend is the fact that there are now far fewer IPOs compared to years past. In 1999, 188 technology companies went public, but in 2014 there were just 55 and given the number of IPO’s this year, 2014 may be remembered as a banner year.

As a result, the value of stock options to employees has been materially diminished when compared to years past. Employees understand that when an IPO is less likely, the value of their options is greatly reduced. And, even if they are confident of a start-up’s IPO chances, waiting for more than a decade to share in the value they are helping to build is unappealing. A 25-year old engineer isn’t excited about waiting until his or her late-thirties to buy a house. He or she is also unenthusiastic about the risk associated with keeping the bulk of their net worth tied up in a single stock for many years.

Meanwhile, mature, publicly traded tech companies are sitting on mountains of cash. They offer big salaries and bonuses, offer amazing health care, and provide luxury buses to work and nap rooms when they get there. Without stock options as a meaningful incentive, most private companies can’t compete with that kind of current cash compensation and perks.

As a result, private companies are increasingly at a competitive disadvantage in the fight to recruit the best employees. If you’re a talented engineer who could work anywhere, why take a chance on an uncertain IPO a decade from now when you can get paid significant cash annually at one of Silicon Valley’s large, publicly traded tech companies?

Liquidity is the Answer

To regain the upper hand in the recruiting wars, the smartest private companies are enabling controlled secondary liquidity to give stock options value again.

There are multiple forms that liquidity might take and they tend to correspond to the maturity of the company. In the earlier stages, companies can informally let employees seeking to sell their stock know the types of buyers with whom the company is comfortable. Increasingly, companies are relying on intermediaries like SharesPost as a way to offload the work of executing these transactions smoothly.

As the volume of secondary transactions increases, companies create more structured programs. One version has become known as a “ROFR” or Right of First Refusal program. In a ROFR program, the company or its agent keeps a handful of deep-pocketed investors up-to-date on the company’s financial progress. As employees come to the company looking to sell their stock, the company refers them to these ROFR buyers and provides approved forms to implement the transactions.

The largest private companies – unicorns – also run formal liquidity programs. Generally, these take the form of a tender offer funded by the company or a company selected institutional investor. Leveraging a platform like the NASDAQ Private Market, the company proactively invites large numbers of employees to sell at a set price. Restrictions on the number of shares an employee might sell ensure that employees remain vested in the success of the company over the long term.

These strategies, each in their own way, turn stock options into cash for employees. Instead of viewing options as a lottery ticket gathering dust in a desk drawer, they become a down payment for a house. Not someday, but sometime this year.

The Bottom Line

Employee stock options can be a powerful way to recruit the most talented people to a private company and motivate them to do great things. But as these companies began to push back the timeline to an IPO, those options began to lose their appeal. Leading private companies are breathing new life into equity incentives by offering some form of company controlled liquidity.

Greg Brogger is founder and CEO of SharesPost, Inc., parent company of SP Investment Management, investment advisor to the SharesPost 100 Fund. He is also the founding President of the NASDAQ Private Market, a joint venture between SharesPost and the NASDAQ OMX Group, where he continues to serve on the Board.

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CONFLICTS

This report is being published by SharesPost Research LLC, and distributed by SharesPost Financial Corporation, a member of FINRA/SIPC. SharesPost Research LLC, SharesPost Financial Corporation and SP Investments Management, LLC, an investment adviser registered with the Securities and Exchange Commission, are wholly owned subsidiaries of SharesPost, Inc.

Recipients who are not market professionals or clients of SharesPost Financial Corporation should seek the advice of their own personal financial advisors before making any investment decisions based on this report. None of the information contained in this report represents an offer to buy or sell, or a solicitation of an offer to buy or sell, any security, and no buy or sell recommendation should be implied, nor shall there be any sale of these securities in any state or governmental jurisdiction in which said offer, solicitation, or sale would be unlawful under the securities laws of any such jurisdiction.

This report does not constitute an offer to provide investment advice or service. Registered representatives of SharesPost Financial Corporation do not (1) advise any member on the merits or advisability of a particular investment or transaction, or (2) assist in the determination of fair value of any security or investment, or (3) provide legal, tax, or transactional advisory services.

ANALYST CERTIFICATION

The analyst(s) certifies that the views expressed in this report accurately reflect the personal views of such analyst(s) about any and all of the subject securities or issuers, and that no part of such analyst compensation was, is, or will be, directly or indirectly related to the specific views contained in this report.

Analyst compensation is based upon various factors, including the overall performance of SharesPost, Inc. and its subsidiaries, and the performance and productivity of such analyst, including feedback from clients of SharesPost Financial Corporation and other stakeholders in our ecosystem, the quality of such analyst’s research and the analyst’s contribution to the growth and development of our overall research effort. Analyst compensation is derived from all revenue sources of SharesPost, Inc., including brokerage sales.

DISCLAIMER

This report does not contain a complete analysis of every material fact regarding any issuer, industry, or security. The opinions expressed in this report reflect our judgment at this date and are subject to change. The information contained in this report has been obtained from sources we consider to be reliable; however, we cannot guarantee the accuracy of all such information.

Any securities offered are offered by SharesPost Financial Corporation, member FINRA/SIPC. SharesPost Financial Corporation and SP Investments Management are wholly owned subsidiaries of SharesPost, Inc. Certain affiliates of these entities may act as principals in such transactions.

Investing in private company securities is not suitable for all investors. An investment in private company securities is highly speculative and involves a high degree of risk. It should only be considered as a long-term investment. You must be prepared to withstand a total loss of your investment. Private company securities are also highly illiquid and there is no guarantee that a market will develop for such securities. Each investment also carries its own specific risks and you should complete your own independent due diligence regarding the investment, including obtaining additional information about the company, opinions, financial projections and legal or other investment advice.

Accordingly, investing in private company securities is appropriate only for those investors who can tolerate a high degree of risk and do not require a liquid investment.

SharesPost, the SharesPost logo, My SharesPost, the SharesPost Index, and SharesPost Investment Management are all registered trademarks of SharesPost, Inc. All other trademarks are the property of their respective owners.

Copyright SharesPost, Inc. 2019. All rights reserved.

Greg Brogger

Greg Brogger

Greg Brogger is the CEO and Founder of SharesPost, Inc. He founded SharesPost in early 2009 to bring transparency, efficiency and scale to private securities transactions.
PLEASE READ THESE IMPORTANT LEGAL NOTICES & DISCLOSURES

CONFLICTS

This report is being published by SharesPost Research LLC, and distributed by SharesPost Financial Corporation, a member of FINRA/SIPC. SharesPost Research LLC, SharesPost Financial Corporation and SP Investments Management, LLC, an investment adviser registered with the Securities and Exchange Commission, are wholly owned subsidiaries of SharesPost, Inc.

Recipients who are not market professionals or clients of SharesPost Financial Corporation should seek the advice of their own personal financial advisors before making any investment decisions based on this report. None of the information contained in this report represents an offer to buy or sell, or a solicitation of an offer to buy or sell, any security, and no buy or sell recommendation should be implied, nor shall there be any sale of these securities in any state or governmental jurisdiction in which said offer, solicitation, or sale would be unlawful under the securities laws of any such jurisdiction.

This report does not constitute an offer to provide investment advice or service. Registered representatives of SharesPost Financial Corporation do not (1) advise any member on the merits or advisability of a particular investment or transaction, or (2) assist in the determination of fair value of any security or investment, or (3) provide legal, tax, or transactional advisory services.

ANALYST CERTIFICATION

The analyst(s) certifies that the views expressed in this report accurately reflect the personal views of such analyst(s) about any and all of the subject securities or issuers, and that no part of such analyst compensation was, is, or will be, directly or indirectly related to the specific views contained in this report.

Analyst compensation is based upon various factors, including the overall performance of SharesPost, Inc. and its subsidiaries, and the performance and productivity of such analyst, including feedback from clients of SharesPost Financial Corporation and other stakeholders in our ecosystem, the quality of such analyst’s research and the analyst’s contribution to the growth and development of our overall research effort. Analyst compensation is derived from all revenue sources of SharesPost, Inc., including brokerage sales.

DISCLAIMER

This report does not contain a complete analysis of every material fact regarding any issuer, industry, or security. The opinions expressed in this report reflect our judgment at this date and are subject to change. The information contained in this report has been obtained from sources we consider to be reliable; however, we cannot guarantee the accuracy of all such information.

Any securities offered are offered by SharesPost Financial Corporation, member FINRA/SIPC. SharesPost Financial Corporation and SP Investments Management are wholly owned subsidiaries of SharesPost, Inc. Certain affiliates of these entities may act as principals in such transactions.

Investing in private company securities is not suitable for all investors. An investment in private company securities is highly speculative and involves a high degree of risk. It should only be considered as a long-term investment. You must be prepared to withstand a total loss of your investment. Private company securities are also highly illiquid and there is no guarantee that a market will develop for such securities. Each investment also carries its own specific risks and you should complete your own independent due diligence regarding the investment, including obtaining additional information about the company, opinions, financial projections and legal or other investment advice.

Accordingly, investing in private company securities is appropriate only for those investors who can tolerate a high degree of risk and do not require a liquid investment.

SharesPost, the SharesPost logo, My SharesPost, the SharesPost Index, and SharesPost Investment Management are all registered trademarks of SharesPost, Inc. All other trademarks are the property of their respective owners.

Copyright SharesPost, Inc. 2019. All rights reserved.