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Term Sheet — Friday, August 22

Friday Feedback

The rain is falling, the deal markets are sluggish and it’s good to be back in the home office after a quick sojourn to NYC. In other words, it’s time for some Friday Feedback.

You sent in tons of emails this week about the Catch-22 faced by early startup employees, when it comes to whether or not to exercise vested stock options (in the context of companies restricting secondary share sales, even to cover tax obligations). So let’s get to a bunch of them:

Lee: “The equitable solution is to revise the tax code so that an option holder’s actual realizations (once they sell stock acquired thru option exercise) are taxed and not paper gains or losses at exercise.
In virtually every other type of investment (capital gain on stock sale, real estate, etc) individuals are taxed at realization. For example if a home owner has their property value reappraised their property taxes may go up but they don’t pay capital gains on the paper gain.”

Anon: “I’m really glad you brought up this topic. It’s something I’m currently grappling with, as I left my job at a pre-IPO startup about 2 months ago and now have to make the decision on whether to buy my options or not (and how to pay for the options and the corresponding tax bill). But I think there is a critical point you didn’t include: the potential over-valuation of mature start-ups. In my situation, the current ‘value’ of the stock is around $20 according to the most recent round of funding for the company. However, I don’t think there’s any way they’ll get that in an IPO. My guess is that $10 is more realistic. I actually have no problem paying the tax bill on my options but I do take issue with paying taxes on a gain in value that I don’t think is realistic and won’t be maintained once the shares actually become liquid. In my case, at the current valuation, I’ll pay about as much in taxes as I will for the options themselves – bringing my upfront cost to purchase the option above what I consider a realistic IPO price. If that’s the case, I’m better off passing on my options and just buying the stock outright when they IPO. So really, what was the purpose of the options in the first place? (For the sake of simplicity – I’m ignoring potential tax breaks due to losses.)

Jared: The option that is really common that people don’t talk about that often is something called a forward contract. This is the one companies hate. It’s an IOU of sorts. A contract that says “I’ll sell you the shares for $XX when I can.” Technically, the employee isn’t selling the shares on that date, but the contract guarantees the buyer the right to those shares when the employees do have ability/right to sell or transfer them. There is little that the company can do to get around this as far as I know. Lots of companies put legal language in their employment contracts that isn’t enforceable… but I’d guess that even if the companies tried to prevent forward contracts, they couldn’t. In these contracts, the employee is often given money (or part of the money) up front and the employee uses that to exercise the shares, pay estimated taxes, and pockets the rest. Some of these contracts have upside shares (the buyer will split upside, above an agreed upon price, at some rate with the selling employee), but most are just a sale price they agree upon.”

Dave: “There is an easy solution for the problem that you described. Most private companies don’t want there shares floating around publicly for anyone to buy. What we do and many others have done is to grant RSUs instead of options. When they vest, we are required to pay taxes on them so we net settle and they get to keep the remaining shares after tax. If they leave, they have already paid the tax and they didn’t have to come up with the cash.”

GH: “VCs should care more about future founders and angels. If you are eating ramen for years as an employee and then get your options effectively pulled after the fact, you can’t keep playing the game. You can’t be an angel, you can’t be a VC, you can’t be a founder. Plus you’re substantially decreasing the pipeline of people willing to take risks on joining small teams. That these games are being played by some of the biggest names is a huge issue for all firms – these are the people who have mindshare as brands and as places to work. The Google and Microsoft millionaires are what encouraged people to drop out of Stanford to start firms or to join firms created by Stanford dropouts. If being an early Uber employee and then losing a political game means you never make any money while living in an area where a studio apartment costs $3000 a month, everyone’s job gets that much harder.”

Henri: “You’re very right to point out that startup employees have many challenges managing their option exposures, beyond simply the business success of their firms. Typically, for instance, an employee’s voluntary termination results in loss of all unvested options AND loss of all vested options if not exercised within 90 days of termination. Not often discussed, but in the event of disability or death, a startup employee’s family or estate will also have limited time to exercise vested options or risk forfeiting those options as well.”

Eric: “One solution is ‘longer exercise periods post-employment.’ When I consult/advise companies for equity, I usually ask for (and receive) a 12-month exercise period. Granted, most employees don’t know to ask for this or don’t have the leverage to get it. But companies can offer this retroactively if they are going to avoid allowing for liquidity opportunities. Also, this perk could be given upon certain conditions – for example, departures under certain circumstances but not others.”

Andy: “I believe companies should award these early employees with liquidity for their services. The relationship between the seller and company is very important in getting these transactions through. In addition, it is vital for broker-dealers in the secondary market to have strong relationships with these private companies in order to conduct business in a professional matter and respect the privacy of sensitive information. I believe that all parties can work together in order to keep an efficient marketplace for these types of transactions.”

Have a great weekend…


• Clayton, Dubilier & Rice has agreed to purchase $500 million of convertible preferred shares in CHC Group Ltd. (NYSE: HELI), a provider of commercial helicopter services to the offshore oil and gas industry, via a private placement.

CD&R also plans to purchase upwards of another $100 million worth of shares that CHC is making available to existing shareholders via a rights offering, depending on how many of those shares first get bought by others. Based on the original $500 million, CD&R would hold a 45% ownership stake in CHC on an as-converted, pro-forma basis.


• Jaunt, a Palo Alto, Calif.-based developer of full-stack hardware and software solution for cinematic VR, has raised $27.8 million in Series B funding. Highland Capital Partners led the round, and was joined by Google Ventures and return backers Redpoint Ventures, British Sky Broadcasting and individual angels.

YPX Cayman Holdings Co., a Shanghai-based quick service restaurant chain, has raised $25 million in Series D funding. Maybank Private Equity led the round, and was joined by return backers like LionRock Capital, Ignition Capital, Koh Boon Hwee (ex-chairman of DBS Bank and Singapore Airlines) and Peter Tan (ex-president of McDonalds Greater China).

• Claret Medical, a Santa Rosa, Calif.-based developer of cerebral protection solutions during structural heart, vascular and cardiac surgery procedures, has raised $18 million in Series B funding. Santé Ventures led the round, and was joined by Easton Capital and Lightstone Ventures.  

• Hightower, a New York-based online platform for the commercial leasing industry, has raised $6.5 million in Series A funding. Bessemer Venture Partners and Thrive Capital co-led the round, and were joined by fellow seed backers RRE Ventures, Red Swan Ventures, David Tisch, Lee Linden and Brandon Shorenstein.

• Fancred, a Boston-based sports fan community for capturing and sharing on-field moments, has raised $3 million in VC funding. Return backers Atlas Venture and Militello Capital co-led the round, and were joined by new investor Breakaway Innovation Group.

• Mark One, maker of a “cup that automatically tracks your consumption to help you make healthier choices,” has raised $3 million in seed funding co-led by Felicis Ventures and Horizons Ventures.

• Groupize Inc., a Beverly, Mass.-based provider of group hotel and property booking management solutions, has raised $2 million in Series A-1 funding from firms like Thayer Ventures and Golden Seeds.


• Affinity Equity Partners and CVC Capital Partners are among likely bidders for South Korean car rental company KT Rental, according to Reuters. The deal could be valued at nearly $800 million. Read more

• Global Franchise Group, a portfolio company of Levine Leichtman Capital Partners, has acquired Hot Dog on a Stick, operator of 92 hot dog and lemonade locations. No financial terms were disclosed.

• Leonard Green & Partners has acquired Mister Car Wash, a Tucson, Ariz.–based car-wash operator, from ONCAP. No financial terms were disclosed. Harris Williams & Co. managed the process.

• Olympus Partners has acquired Innovative XCessories & Services LLC, a Huntsville, Ala.–based provider of upfit services and accessories to the automotive aftermarket and original equipment manufacturers.

• Resilience Capital Partners has acquired a majority stake in Hynes Industries Inc., a Youngstown, Ohio-based maker of rolled formed shapes, strip steel and flat wire. No financial terms were disclosed.

• The Riverside Company has acquired Lexipol, an Aliso Viejo, Calif.-based provider of policy management and training platforms for public safety organizations. No financial terms were disclosed.


• Vision Capital has hired Rothschild to explore an IPO for BrightHouse, a UK-based rent-to-own retailer, according to the FT. Read more


• TPG Capital is running a parallel sale process for American Tire Distributors Holdings Inc., a Huntersville, N.C.-based tire distributor that filed for an IPO back in June, according to the WSJ. Several private equity firms reportedly are interested in buying ATD, in a deal that could be valued at more than $3 billion. Read more.


• IPC The Hospitalist Company Inc. (Nasdaq: IPCM) has acquired two Florida practices: Eddin Medical Services, a post-acute practice in the Daytona Beach area, and TriCounty Hospitalists, an acute care practice in the Orlando area. No financial terms were disclosed.



• The Blackstone Group is in talks to invest in a Arkkan Capital Management, a new Hong Kong-based distressed hedge fund led by Jason Brown (ex-head of Goldman Sachs’s special situations group), according to Bloomberg. Read more

• Holtzbrinck Ventures reportedly has agreed to acquire a 2.5% stake in European incubator Rocket Internet, in exchange for its stakes in several Rocket-backed startups. Rocket is expecting to go public later this year with a valuation in excess of €4 billion. 


• Jim Murray has joined Vector Capital as chief financial officer. He previously spent 14 years with Blum Capital as CFO and chief administrative officer.

• Rick Walsh has joined Court Square Capital as head of investor relations, as first reported by peHUB. He previously spent six years with Lee Equity Partners.

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