Loans can burn start-up workers amid economic downturn

SAN FRANCISCO. Bolt Financial, an upfront payment company, launched a new employee program last year. They had stock options in the company, some of which were worth millions of dollars on paper, but they couldn’t touch that money until Bolt was sold or went public. So Bolt began making loans to them, some in the hundreds of thousands of dollars, against the value of their shares.

Bolt laid off 200 workers in May. This put a 90-day deadline for those who took loans to return the money. The company was trying to help them figure out repayment options, said a person with knowledge of the situation, who spoke anonymously because the person was not authorized to speak publicly.

The Bolt program was the most extreme example of a growing ecosystem of loans for workers in private tech startups. In recent years, companies such as Quid and Secfi have sprung up to offer loans or other forms of financing to budding employees, using the value of their private companies’ shares as a kind of collateral. These providers estimate that startup employees around the world have at least $1 trillion worth of capital that can be leveraged.

But how the startup economy is about to deflateBolt’s situation, shaken by economic uncertainty, soaring inflation and interest rates, is a warning of the unreliability of these loans. While most are designed to be forgiven if a startup fails, employees can still face a tax bill as loan forgiveness is treated as taxable income. And in situations like Bolt’s, loans can be difficult to repay on short notice.

“No one thought about what happens when things go wrong,” said Rick Heitzmann, an investor at FirstMark Capital. “Everyone thinks only about the pros.”

The proliferation of these loans has caused controversy in Silicon Valley. Supporters said the loans were necessary to enable employees to participate in the technological wealth-creation mechanism. But critics said the loans created unnecessary risk in an already risky industry and were reminiscent of the dot-com era in the early 2000s, when many tech workers were badly burned out due to loans linked to their stock options.

Ted Wang, a former aspiring lawyer and investor in Cowboy Ventures, was so alarmed by the loans that he wrote a blog entry in 2014:playing with fire, ”The advice is against them for most people. mr. Wang said he received a new round of calls about loans every time the market overheated and always felt compelled to explain the risks.

“I saw something go wrong, very bad,” he wrote on his blog.

Startup credits are related to how workers are usually paid. As compensation, most employees of private technology companies receive stock options. Options must eventually be exercised or bought at a set price in order to own the shares. Once someone owns shares, he or she usually cannot cash out until the startup goes public or is sold.

This is where loans and other financing options come to the rescue. The starter stock is used as collateral for these cash advances. Loans vary in structure, but most providers charge interest and take 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 of them are known as non-recourse loans, which means employees are not prepared to repay them if their shares are worthless.

This lending industry has flourished in recent years. Many of the providers were created in the mid-2010s as hot startups such as Uber and Airbnb delayed 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 handcuffed with gold and couldn’t leave their jobs because their stock options had become so valuable that they couldn’t afford to pay taxes based on current market value when they were exercised. Others are tired of sitting on options while waiting for their companies to go public.

The loans have given startup employees cash they can use, including money to cover the cost of buying their stock options. However, many tech workers don’t always understand the intricacies of shared compensation.

“We work with super smart Stanford computer science graduates, but no one explains anything to them,” said Oren Barzilai, chief executive Equitybee is a website that helps aspiring entrepreneurs find investors for their shares.

Secfi, a provider of financial and other services, has provided $700 million in cash funding for start-up workers since it opened in 2017. Since 2016, Quid has provided hundreds of millions of loans and other funding to hundreds of people. His last $320 million fund backed by institutions including Oaktree Capital Management, and charges loan originators fees and interest.

So far, less than 2 percent of Quid’s loans have been unavailable, meaning the stock’s market value has fallen below the cost of the loan, said Josh Berman, the company’s founder. Secfi said 35 percent of its loans and funding have been fully repaid, with a loss rate of 2 to 3 percent.

But Frederick Meinhardt, chief executive of Secfi, predicted that the next six to twelve months could be difficult for tech workers if their stock options tumble in value during the economic downturn, but they borrowed at a higher price.

“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 start-ups. The main reason is that traditional banks will not lend start-up capital. “Too much risk,” he said.

Equitybee estimates that startup employees pay $60 billion a year to exercise their stock options. For a variety of reasons, including being unable to afford them, more than half of the options written never materialize, meaning that workers forego some of their compensation.

mr. Forbus said he had to carefully explain the terms of such deals to his clients. “Contracts are very hard to understand and they don’t really reflect the math,” he said.

Some start-up workers regret taking out a loan. Grant Lee, 39, spent five years at Optimizely, a software startup, accumulating millions in stock options. When he left the company in 2018, he had a choice: buy his options or give them up. He decided to take advantage of them by taking out a $400,000 loan to help with expenses and taxes.

In 2020, Optimizely was acquired by Swedish software company Episerver at a price that was below its latest private valuation of $1.1 billion. This meant that stock options held by employees at a higher valuation were worth less. For Mr. Lee, the value of his Optimizely shares fell below the value of the loan he took out. Even though his loan has been forgiven, he still owes about $15,000 in taxes, as loan forgiveness is considered taxable income.

“I didn’t get anything, and besides, I had to pay taxes for not getting anything,” he said.

Other companies use loans to give their workers more flexibility. In May, Envoy, a San Francisco-based workplace software startup, used Quid to offer non-recourse loans to dozens of its employees so they could then get cash. Envoy, which was recently valued at $1.4 billion, did not encourage or discourage people from taking out loans, said Larry Gadea, chief executive.

“If people believe in the company and want to double down and see how much better they can do, this is a great option,” he said.

In an economic downturn, credit terms can become more onerous. The IPO market is frozen, pushing potential payouts into the future, and a depressed stock market means private startup shares are likely to be worth less than they were during the boom, especially in the past two years.

Quid is adding more underwriters to help find the right value for the seed stocks it lends against. “We have become more conservative than in the past,” he said. Berman said.

Bolt appears to be a rarity in the sense that it has offered high-risk personal recourse loans to all of its employees. Ryan Breslow, founder of Bolt, announced the program with congratulations on twitter in February, writing that it showed that “we simply CARE about our employees more than most.”

The company’s program was designed to help employees realize their shares and cut taxes, he said.

Bolt declined to comment on how many laid-off employees were affected by loan repayments. He offered employees the choice of returning their start-up shares in the company to pay off their loans. business insider previously reported to the offer.

mr. Breslow, who stepped down as chief executive of Bolt in February, did not respond to a request for comment on the layoffs and loans.

In recent months, he helped found Prysm, a provider of non-recourse loans to startups. In presentation materials sent to investors that were reviewed by The New York Times, Prysm, which did not respond to a request for comment, touted Mr. Breslow as its first client. The presentation said that by borrowing against the value of his Bolt shares, Mr. Breslow took out a $100 million loan.