ESO's Monthly Start-Up

August 2023

Employees Running Low on Options

Aside from the hybrid roles and flexible work environment you might find, there’s a key perk that attracts many top talents to early stage start-ups: stock options.

While startups aren’t able to offer top talent the same salary or benefit packages that a larger tech player might, they are able to offer larger, more promising equity packages. If the company ends up having a successful exit or entry into the public markets in the future, these options packages can be extremely lucrative… if they are exercised.

While one would think that employees would be taking advantage of the ownership opportunity, Carta’s most recent State of the Private Markets implies otherwise. As the infographic below shows, in 2023 employees exercised a record low 26% of vested options.

What is causing this decline in option exercising? The answer appears to be two fold. First, valuations have been declining across all stages of VC-backed companies, with late stage being the most impacted by these declines. For employees who joined startups in 2020 and 2021, there is a high likelihood that their option packages might be underwater now. This means that the exercise price on the options is greater than the current Fair Market Value of the stock. For example, you may have options with an exercise price of $20 a share, while the stock is only valued at $14 a share. In this situation, you are effectively having to overpay for the company stock.

Exercise rates may also be low right now too due to bearishness surrounding exit prospects for startups. The current economic environment has been plagued by a lack of exits and IPOs, as well as ongoing news about the difficulties of raising capital and startups failing. With option exercise sometimes requiring a considerable amount of capital commitment, employees might be weary tying so much money up in an illiquid asset with high risk levels.

Wait, but why were exercise rates below 50% even in 2021 when VC was booming? Some of the answer to that question might be in line with the point above about the capital commitment required for exercising. In their 2022 Employee Stock Options Report, Carta ran a survey for why employees are not exercising their options. The results were extremely interesting. Employees reported they didn’t exercise options in the past because they:

  • Couldn’t afford the cost to exercise or associated taxes (23%)

  • Thought it was too much of a financial risk (18%)

  • Were worried about making a mistake or thought they already owned them (13%)

  • Didn’t think their options were worth anything (11%)

While cost and financial worries made up about 41% of employee rationale, 13% did not exercise because they lacked education.

Why this matters: Employees are leaving an extremely high number of options on the table right now. Based on historical figures, they have never exercised at a rate above 50%. These packages can be extremely fruitful if the company performs well, and employees that fail to educate themselves on the value of their option packages may miss out on a significant return in the future. Education on option exercise, as well as solutions for exercising with less personal financial risk, will help employees to make informed decisions about how to take advantage of their entire compensation packages at their company.

Tips of the trade

A section where we provide helpful tips for anyone with stock options or shares at private companies.

What is Rule 701?

If you own a public company’s stock, you’ve most likely taken a look at their financials. At the very least, you are aware that their financial statements are publicly available.

What most startup employees don’t know is their company’s financials (often treated like a state secret) are also potentially available.

Startups begin life exempt from SEC reporting, but if they aspire to go public, they will one day need to report their financials quarterly. On their way to IPO, Rule 701 creates a sort of public company on training wheels. Basically, if your company reaches a certain size (both in headcount and valuation) they are required to report certain information in a Rule 701 Disclosure.

In order to qualify for Rule 701 reporting, a company must issue an aggregate total of ten million dollars in stock options during any consecutive 12-month period. For example, if a company issues one million stock options with a strike price of $10 per share, they would hit that mark.

What is a Rule 701 Disclosure?

Companies above the Rule 701 threshold must provide certain information to anyone looking to purchase stock options. They are not required to file these documents publicly, but they do include audited financial statements.

The purpose of Rule 701, much like the rationale for public company filings, is to provide prospective purchasers of the company’s stock with the information necessary to make an educated decision about their exercise.

The information in a Rule 701 Disclosure typically contains a summary of company’s stock plan, risks associated with the investment, and GAAP compliant financial statements (balance sheet, income statement, cash-flows, and capitalization table).

Why should employees care about Rule 701?

If you are ever planning to exercise your stock options, you may as well make the most educated decision possible. There is no harm in asking your stock plan administrator if the company is eligible for Rule 701 disclosures.

Reviewing these documents yourself or with a financial advisor can provide key insights into whether or not you should fork up your own cash to exercise.

Financing your option exercise can be expensive and a require a large capital outlay. Feel free to reach out to us to discuss your options for partnering with ESO to exercise your options risk-free.

The ESO Fund does not provide legal, financial, or tax advice.

Layoff Declines Continue

Layoffs for July have followed the trend we have seen over the past couple of months, and have seen further declines. While the total number of employees laid off in July declined by 24%, the total number of companies that experienced layoffs saw an even larger decline at 42%. Total layoffs for the month were led by Microsoft laying off roughly 1,000 employees and Amdocs laying off 2,000.

Why this matters: As the layoff trends continue to normalize, and the IPO market begins to heat up again, we hope to convert this section of the newsletter into an IPO tracker within the next couple of newsletter editions. Stay tuned for that update!

Brought to you via layoffs.fyi

Secondary Market Sentiment:

The graph below displays the ratio of buyers vs sellers for a given month on the private secondary market. Months with more buyers than sellers are displayed in green while months with more sellers than buyers are displayed in red. All data pulled from Zanbato, the below list does not imply completed transactions, simply intent to either buy or sell shares.

No major changes in secondary market trends as we begin the second half of 2023. As we have hit on many times now, it will likely take an opening in the IPO window to get things started.

We are hopeful that towards the end of the year and into 2024 things will ramp up a bit. This is one of those markets where any momentum will snowball. There is certainly plenty of cash sitting on the sidelines in the event things turn around. Momentum has begun to pick up in the public markets, so it is possible it is only a matter of time before secondary transactions heat up.

Public Multiples Check-in: "Yesterday's Price is not Today's Price"

Multiples have been recovering after months of steep declines year over year, though Consumer and HealthTech both saw some multiple compression in July, a reversal from the uptick in their multiples from last quarter. However, three out of the seven sectors that we are tracking are still seeing increases in their forward multiples compared to this time last year, which is a positive signal that the public markets are showing resiliency in the wake of Fed interest rate hikes. Notably however, Enterprise SaaS and Real Estate multiples continue to trail their previous forward multiples from last year.

Why this matters: The public markets have shown resiliency in the wake of interest rate hikes and inflation, which came as a surprise to many who were predicting a negative market response. While we are definitely not out of the woods yet, the NASDAQ and S&P gains this past year are reassuring. Notably, however, private markets are lagging the uptick that the public markets are experiencing. The graph below shows the contrast between public and private markets through 2019, as presented by Forge Global.

July's Top Ten:

  1. Bolt has made headlines this month, but not for the right reasons. News broke that co-founder Ryan Breslow was subpoenaed along with the company last year, and a letter authored in April by a lawyer representing Bolt investors said the SEC was investigating whether federal securities laws were violated in connection with statements made when Bolt was raising money in 2021.

  2. Bye bye birdie: Twitter has officially rebranded to “X” under the leadership of Elon Musk. For Musk, this reflects his plans of moving Twitter from just a conversation app to an “everything app”.

  3. Mark Zuckerberg launched Threads this month, and it is expected to be a direct competitor to Twitter. However, while the new company had an initial surge of sign ups to around 100 million, Zuckerberg has recently told staff that more than half aren’t using the app.

  4. Deep layoffs have brought Cameo’s headcount to under 50 workers, a number that is roughly one tenth of the number of employees Cameo employed just over a year ago. As the company continues to struggle, some investors are hoping the company might find a buyer, though at a potential price tag of roughly $50 million, it would be a massive haircut to the $1 billion valuation they once raised at.

  5.  Sequoia is facing a management shake-up, with 5 partners having left the firm this past month. The recent departures are the latest indication of how leader Roelof Botha is reshaping the firm. The exits have reduced the number of the firm’s investment staff by 15% to 28.

  6. SpaceX, the most highly valued private tech company in the U.S., is forecasting to double its revenue to $8 billion, according to people familiar with the discussions. The company has been valued in a secondary sale most recently this month at about $150 billion and has assured investors it expects to pull in about $3 billion in operating profits this year.

  7. Oddity Tech, the beauty and wellness company that uses AI to develop cosmetics and has former Israeli defense officials on staff, debuted on the public markets with a 35% pop as the IPO market heats up. Oddity and its shareholders raised about $424 million in the deal. Oddity is currently trading at $53.29 a share, about a 5% increase from their IPO debut close price.

  8. OpenAI is gearing up to raise its second fund, which according to representatives for the company, will be far larger than its $175 million debut. The hunt is on for the company to find a more established investor to lead the charge.

  9. Canned water company Liquid Death has hired Goldman Sachs for an initial public offering as soon as next spring. The company was valued at $700 million in a $70 million financing round led by Science Ventures last year.

  10. Kim Kardashian’s Skims is now worth $4 billion after the apparel company raised a $270 million round in July. This is up from the $3.2 billion valuation investors gave the company last year.

Why this matters: We discussed Cava’s IPO success in last month’s newsletter edition, and this positive entry into the public markets has been duplicated by Oddity this past month. Additionally, Liquid Death’s IPO filing and Shein IPO rumors this month are continued positive signals for the industry. As we are approaching the fall and back end of 2023, we hope to see some further movement in companies both filing for IPO and finally opening up the IPO market.

Startups that are still hiring!

Open positions are per the company's website.