Your questions about Upsyde & options financing answered.

We are friends and trusted colleagues. We are longtime operators of private companies and are respected in the tech and venture communities. We have spent countless hours sitting next to you at hackathons and all-hands meetings, huddled around estaff tables and board rooms, and holding town hall meetings and ask-me-anythings. We have advised companies through IPOs, acquisitions, tender offers, company buybacks and secondaries. We are who your friends are calling when they want to talk about their equity.

The options financing market, and the broader secondary market, are still very opaque, which attracts ne’er-do-wells and opportunistic personas. That’s not to say that there aren’t reputable people moving around in these spaces. Rather, it just means there’s a ton of noise and lots of tire kickers on both the sell- and buy-side. Given the complex, sensitive and intimate nature inherent in options financing, we have decided to identify long-standing trusted relationships and build off these.

That said, we are soft-launching with our friends and friends of friends, and their companies, quite frankly, because the biggest reason options financing fails is lack of counter-party trust. In the meantime, please sign up for the waitlist, ask a question or get connected through a mutually trusted connection.

Options financing, simply put, is when an employee uses proceeds from a third party to fund the exercise of her stock options. Oftentimes, these deals look like traditional loans, but for lots of legal reasons, most firms that offer options financing avoid calling them “loans.” Sometimes they’re called “pre-paid, variable, forward contracts,” or “personal financing contracts,” or some other crafty variation.

There are three primary features commonly used in options financing deals that will determine the cost of the financing: 

(1) The contract fee. Think of a contract fee as an origination fee or the points you would pay when you get a mortgage. This amount is generally expressed as a percentage of the financing amount, but sometimes can be a flat dollar amount. The market fee range is 2% to 5%.   

(2) The investment return. Think of this as an annual interest rate like the one you would pay on any other loan. This amount is generally expressed as a percentage as well, and is typically a variable rate that is tied to the “prime rate.” The investment return usually compounds quarterly and increases in later years on any financing balance that remains outstanding. The investment return rate ranges anywhere from prime to prime +8%.

(3) The stock incentive. Think of this as a profit share, which is the portion of your “profits” that you will “share” with the investor at the time you sell your shares. This amount will generally be expressed as yet another percentage, and will vary depending on a number of inputs to the investor’s model. Just like any other investment strategy, investors have certain parameters and return hurdles that they’re targeting. The factors influencing their models typically include: (i) stock option exercise price, (ii) fair market value of company common stock (FMV or 409a), (iii) number of company shares outstanding (on a fully-diluted basis), (iv) estimated company valuation, (v) estimated secondary sale price, and (vi) estimated tax rates that apply (federal and state), among others. Given all the inputs and how wildly they can vary from deal to deal, stock incentives can range anywhere from 3% to 50%.

There are lots of reasons you might want to finance your options exercise.

Top 3 reasons to do it:

1) Upside. Because options financing does not involve you selling your shares today, you get the benefit of future gains when your company’s equity value increases. 

2) Tax efficiency. When done correctly, financing can result in more beneficial tax treatment when you sell your shares (e.g., being taxed at long-term capital gains rates, as opposed to ordinary income rates). There’s lots of ways to do this incorrectly though, so always consult experts.

3) Non-recourse. Again, when done correctly (and unless you default), your financing should be collateralized only by your shares —meaning if the value of your shares at the time of repayment is less than the principal amount of your financing, you should not be liable for anything beyond the value of your shares. Again, there’s lots of ways to do this incorrectly, so make sure to consult experts.

While there are lots of reasons you might want to finance your options exercise, there are also lots of reasons you might not want to.

Top 3 reasons to not do it: 

1) Company disapproves. Think twice if your company has strong feelings about who sits on its cap table. Spoiler: virtually all companies do. 

2) Too expensive. If the cost of financing exceeds the economic benefits you anticipate (e.g., tax savings), sometimes doing nothing is the better choice.

3) Shady counter-party. Given the relative novelty of options financing, trust on both sides of the transaction is paramount. Options financing firms have to trust that the employee is not going to try to unwind the transaction if the company crushes it, and the employee has to trust that the firm didn’t include a trap door in the financing contract that allows them to come after her house. 

The short answer is yes.

Getting financing to exercise stock options is likely not expressly prohibited by your company. For example, there’s nothing saying you can’t go out and get an unsecured personal loan or a second mortgage on your house, and then use those loan proceeds to exercise your options. Option financing deals are different though, in that they require you to actually or effectively “pledge” your shares as collateral —to make sure you pay them back as agreed when you sell. However, virtually all, if not all, private company stock plans and agreements prohibit using company stock as collateral, and therein lies the rub. Look for the language saying that neither your options nor the underlying shares may be sold, pledged, assigned, hypothecated, transferred or disposed of in any manner.

The only way to know for sure is to ask first. These deals are very nuanced for everyone involved, including your company, and there are so many things to take into consideration. Start a meaningful dialogue with someone who is likely to be empathetic and who will understand the ask and the implications (CFO, GC). If you need help framing the discussion, reach out to us.

Maybe, maybe not. The “springing lien” or “springing pledge” is basically a concept added to a financing contract that doesn’t have company approval, which claims that the employee is not pledging her shares in any way, shape or form. It goes on to say, however, that a pledge will “spring” into existence in the future if she defaults on the financing or when her shares are no longer restricted by the company (e.g., IPO).

The truth is that, whether they’re legal or not, springing pledges most likely go against the intent of the transfer and pledge restrictions in your company’s stock plan. So, if you sign up to one, you’ll have to make sure you don’t trigger it. Your best case scenario if a springing pledge gets triggered, is that you have a legally binding transaction and, potentially, a displeased company.

Disclosing company confidential information, even verbally, without permission is never a good idea, and is almost always a bad idea. Investors, brokers and retail “platforms” will ask you for company financial information, cap table information, stock valuation information (e.g, 409a), stock plans and agreements, and a bunch of other things. It’s safe to say most companies consider all of which to be confidential information. While you’re generally allowed to share some of this information with your legal and financial advisors, that exception is pretty limited to your actual lawyers, accountants and bankers that have fiduciary obligations to you.

Contact us via form or send an email to investors@upsyde.io.