Bolt founder Ryan Breslow recently outlined an ambitious plan to overhaul the employee stock options program at his startup, which is now valued at $11 billion and counting.
He did this by voluntarily adopting four big changes: giving every employee the ability to exercise their stock options early, giving every employee a multiyear post-termination stock options exercise window, offering traditional recourse loans to help employees afford the cost of exercising their stock options, and giving employees a one-time stipend to work with a financial adviser to decide what to do.
Breslow’s Twitter thread sparked a much-needed conversation about what startups can do to fix what’s broken about stock options—and a lot is broken. It seems to have struck a chord. Exercising startup stock is always a risk for employees, but there are ways to help manage that risk, and even reduce it.
Employee risk is not the same as founder risk
By nature, startup founders are bullish about their prospects. However, risk is not evenly distributed across a startup. Investors expect failure and distribute their risk across their investment fund. Founders don’t pay for their stock options, so they’re typically able to move to their next startup without creditors nipping at their heels. Investors also get access to preferred shares, allowing them to jump to the front of the line to recoup their investments if the company fails.
Rank-and-file employees, who may have taken out hundreds of thousands of dollars in traditional loans, typically have the least experience with stock options. They could not only lose their jobs but can also be at risk of losing their investment accounts, savings, and in extreme cases, their homes.
They’re also typically the people in the equation with the least amount of experience with stock options, making life-changing decisions without access to the same privileged information that investors and founders get. And they’re buying common stock, the riskiest class of startup shares.
Breslow rightly highlighted that there is risk to his employees choosing to exercise. But his thread also highlighted that he believes Bolt is a sure bet. As a founder, I can relate to that sentiment, but we also need to realize it’s not the same for our employees.
There are ways for companies to help their employees
Most employees just don’t understand equity: that it can be expensive, that you need to pay taxes, and that it gets more expensive the higher a company’s valuation gets due to those taxes. Companies need to educate them about all the ways they can exercise their stock options.
Companies should also be extending the exercise window for employees who leave. The standard is just 90 days. More companies are extending that window out anywhere from two to 10 years, but employees need to know that they will lose the tax benefits of incentive stock options (ISOs) because they will convert to nonqualified stock options (NSOs).
Finally, they should educate employees on the ways they can exercise their options:
Pay with their own money: This has the highest upside because there’s no loan or interest to pay back. It also has the highest risk because if things don’t go well, they’ll lose their money.
Recourse/personal loans: This has a high upside because they can get the tax benefits of early exercising. However, their personal assets are also on the line. So if things go poorly for the company, they’re still on the hook for the loan plus the interest. Their possessions could be used to satisfy the loan if they can’t pay it. In a worst-case scenario, they’d be forced to file for bankruptcy.
Company recourse loan: This aspect of Breslow’s announcement sparked a lot of the ongoing conversation. The pros and cons are the same as any recourse loan, but there could be further complications. The IRS could count the loan as a gift from the company. So, even if the company forgives the loan, the IRS could still pursue the employee. Even worse, options exercised with a company loan could still be considered “unexercised,” meaning the employee would lose the intended tax benefits of using the loan.
Non-recourse financing: This type of financing has high upside, like a recourse loan, but comes with a lower risk. That’s because personal assets are not put up as collateral. The employee’s exercised shares are the only asset on the line. Like a recourse loan, the employee will need to pay back a fee in addition to the original financed amount, but payment isn’t due until the company exits. If the company never exits, the employee doesn’t pay the financing back. They’ll never owe more than the value of their shares if their shares are underwater.
Secondary market share transactions or tender offers: A tender officer is a buyback program organized by the company. There’s no real downside because employees are selling their equity and getting immediate liquidity. However, they’re forgoing any future upside if the company IPOs. Secondary markets are a similar concept but through a third-party buyer. These usually involve buying and selling the options in a single transaction—a cashless exercise—which can result in negative tax consequences by not holding on to the options for at least a year.
Just wait until an IPO or acquisition: There’s no downside to waiting it out, but there is upside lost. Similar to tender offers or secondary sales, employees usually do a cashless exercise. They also run the risk of losing it if they are unable to exercise within the likely 90-day window.
This is only the beginning of a much-needed conversation
What Breslow got right is that the cost to exercise stock options is high, likely more than a regular employee can afford. He’s also right that exercising early has a clear benefit: It can reduce upfront exercising taxes and start the clock on long-term capital gains. Finally, high exercise costs do lead to “golden handcuffs,” in which employees stick around only because they can’t exercise their options.
However, proposing recourse loans to exercise stock options without the proper guidance is incredibly risky. Employees will consider anything their company shares, or encourages, as safe and vetted.
That’s why founders and companies should be doing more to educate their employees about how equity works and how to weigh the risks of exercising. Doing so will also help to protect their employees from unnecessary risks when making one of the biggest financial decisions of their lives.
Frederik Mijnhardt is the CEO of Secfi.
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