Loans can burn startups in times of crisis

SAN FRANCISCO — Last year, Bolt Financial, a payments startup, launched a new program for its employees. They owned stock options in the company, some of which were worth millions of dollars on paper, but couldn’t touch that money until Bolt sold or went public. So Bolt started giving them loans — some of them as high as hundreds of thousands of dollars — against the value of their stock.

In May, Bolt laid off 200 employees. This set a 90-day deadline for those who took out the loan to pay back the money. The company was trying to help them figure out their coverage options, said a person with knowledge of the situation, who spoke on condition of anonymity because the person was not authorized to speak publicly.

Bolt’s program was the most extreme example of a growing ecosystem of loans for workers at private tech startups. In recent years, companies like Quid and Secfi have sprung up to offer loans or other forms of financing to startups, using the value of their private company’s stock as a kind of collateral. These providers estimate that startups around the world have at least $1 trillion in loanable capital.

But with the fledgling economy now facing deflation caused by economic uncertainty, rising inflation and rising interest rates, Bolt’s situation is a warning about the volatility of these loans. Although most of them are structured to forgive if the startup fails, employees will still be able to pay the tax because the loan forgiveness is treated as taxable income. And in situations like Bolt’s, it can be difficult to pay off loans in a short amount of time.

“No one thinks about what happens when things go bad,” said Rick Heitzman, an investor at FirstMark Capital. “Everybody’s just thinking about the extra side.”

The proliferation of these loans has sparked debate in Silicon Valley. Proponents argued that the loans were necessary for workers to participate in the engine of tech wealth creation. But critics said the loans created unnecessary risks in an already risky industry and were reminiscent of the dot-com era of the early 2000s, when many tech workers were badly burned by loans tied to their stock options.

Ted Wang, a former startup lawyer and Cowboy Ventures investor, was so alarmed by loans that he published a blog post, “Playing with Fire,” in 2014 that advised most people against them. Mr. Wang said he received new calls about loans any time the market overheated and always felt obligated to explain the risks.

“I saw it was wrong, bad wrong,” he wrote in his blog post.

Start-up loans are based on the rules of workers compensation. As part of their compensation, most employees at private tech companies receive stock options. Options must eventually be exercised, or purchased at a specified price, in order to own the stock. Once someone owns the shares, they usually can’t cash them out until the startup exits or sells.

This is where loans and other financing options come in. Initial shares are used as a form of collateral for these cash advances. Loans vary in structure, but most providers charge interest and receive a percentage of the employee’s stock when the company sells or goes public. Some are structured as contracts or investments. Unlike the loans offered by Bolt, most are known as “non-recourse” loans, meaning employees are not expected to repay them if their shares lose value.

This lending industry has experienced a boom in recent years. Many of the providers were created in the mid-2010s, when hot startups like Uber and Airbnb held off initial public offerings as long as they could, reaching private market valuations in the tens of billions of dollars.

This meant that many of their workers were “golden handcuffed” and could not quit their jobs because their stock options had become so valuable that they could not afford to pay the taxes, based on the current market value, on exercise taxes. Others are tired of sitting on options while they wait for their companies to go public.

The loans gave startups cash to use up front, including money to cover the cost of buying their stock options. Still, many tech workers don’t always understand the complexities of equity compensation.

“We’re working with super-smart Stanford computer science AI grads, but nobody’s explaining it to them,” said Oren Barzilai, CEO. Equitybee, a site that helps startups find investors for their stocks.

Secfi, a provider of financing and other services, has now provided $700 million in cash funding to startups since opening in 2017. Quid has provided hundreds of millions in loans and other financing to hundreds of people since 2016. The latest $320 million fund is backed by institutions including Oaktree Capital Management, and it charges origination fees and interest on those who borrow.

So far, less than 2 percent of Quid’s loans have been underwater, meaning the market value of the stock is below the loan rate, said Josh Berman, the company’s founder. Secfi said 35 percent of its loans and financings were repaid in full and that its loss rate was between 2 and 3 percent.

But Frederik Mijhardt, chief executive of Secfi, predicted that the next six to 12 months could be difficult for tech workers if their stock options were reduced during the fall in value, but they took out loans at a higher cost.

“Employees may face retribution,” he said.

Such loans have become more popular in recent years, says JT Forbus, an accountant at Bogdan & Frasco who works with startups. A big reason is that traditional banks won’t lend against startup capital. “There’s too much risk,” he said.

Startups pay $60 billion a year to exercise stock options, Equitybee estimated. For a variety of reasons, including the inability to afford them, more than half of the options granted are never exercised, meaning workers are giving up a portion of their compensation.

Mr Forbes said he had to carefully explain the terms of such deals to his clients. “Contracts are very difficult to understand and don’t really do the math,” he said.

Some startups regret taking out a loan. Grant Lee, 39, spent five years at Optimizely, a software startup, accumulating stock options worth millions. When he left the company in 2018, he had the choice to buy his options or forfeit them. He decided to make them happen, taking out a $400,000 loan to help with expenses and bills.

In 2020, Optimizely was acquired by Episerver, a Swedish software company, for a price that was lower than its last private valuation of $1.1 billion. This means that stock options held by employees at higher valuations were worth less. For Mr. Lee, the value of Optimizely’s stock fell on the loan he took out. Even though his loan was forgiven, he still owed about $15,000 in taxes because the loan forgiveness is considered taxable income.

“I didn’t get anything, and on top of that, I had to pay taxes to get nothing,” he said.

Other companies use loans to give their workers more flexibility. In May, Envoy, a San Francisco workplace software startup, used Quid to offer no-obligation loans to dozens of its employees so they could get cash. Envoy, which was recently valued at $1.4 billion, did not encourage or discourage people from taking out loans, said Larry Gadea, CEO.

“If people believe in the company and want to double down on it and see how much better they can do it, that’s a great option,” he said.

In a downturn, loan terms may become more difficult. The IPO market is frozen, pushing potential returns into the future, and a depressed stock market means that private equity startups are probably worth less than they were during the boom, especially in the past two years.

Quid is adding more underwriters to help the start-up find the right value for the shares it enjoys. “We are more conservative than in the past,” Mr. Berman said.

Bolt seems to be a rarity in that he has offered high-risk personal loans to all of his employees. Ryan Breslow, the founder of Bolt, announced the program a Congratulations to Bloom on Twitter In February, it wrote that it showed that “we simply care more about our employees than most.”

He said the company’s program was aimed at helping employees exercise their shares and reduce taxes.

Bolt declined to comment on how many laid-off employees were affected by the loan repayments. It offered employees the option to return their start-up shares to pay off loans to the company. Business Insider previously reported on the offer.

Mr. Breslow, who stepped down as Bolt chief executive in February, did not respond to requests for comment on the layoffs and loans.

In recent months, he helped found Prysm, a provider of non-recourse loans for start-up capital. In materials sent to investors seen by The New York Times, Prysm, which did not respond to a request for comment, listed Mr. Breslow as its first customer. The presentation said that Mr. Breslow took out a loan for $100 million.

Leave a Comment

Your email address will not be published.