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Loans Could Burn Start-Up Employees in Downturn

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SAN FRANCISCO — Last 12 months, Bolt Financial, a payments start-up, began a recent program for its employees. They owned stock options in the corporate, some value tens of millions of dollars on paper, but couldn’t touch that cash until Bolt sold or went public. So Bolt began providing them with loans — some reaching a whole lot of 1000’s of dollars — against the worth of their stock.

In May, Bolt laid off 200 staff. That set off a 90-day period for many who had taken out the loans to pay the a reimbursement. The corporate tried to assist them determine options for repayment, said an individual with knowledge of the situation who spoke anonymously since the person was not authorized to talk publicly.

Bolt’s program was probably the most extreme example of a burgeoning ecosystem of loans for staff at privately held tech start-ups. In recent times, corporations resembling Quid and Secfi have sprung up to supply loans or other types of financing to start-up employees, using the worth of their private company shares as a form of collateral. These providers estimate that start-up employees around the globe hold not less than $1 trillion in equity to lend against.

But because the start-up economy now deflates, buffeted by economic uncertainty, soaring inflation and rising rates of interest, Bolt’s situation serves as a warning concerning the precariousness of those loans. While most of them are structured to be forgiven if a start-up fails, employees could still face a tax bill since the loan forgiveness is treated as taxable income. And in situations like Bolt’s, the loans could also be difficult to repay on short notice.

“Nobody’s been fascinated with what happens when things go down,” said Rick Heitzmann, an investor at FirstMark Capital. “Everyone’s only fascinated with the upside.”

The proliferation of those loans has ignited a debate in Silicon Valley. Proponents said the loans were crucial for workers to take part in tech’s wealth-creation engine. But critics said the loans created pointless risk in an already-risky industry and were harking back to the dot-com era within the early 2000s, when many tech staff were badly burned by loans related to their stock options.

Ted Wang, a former start-up lawyer and an investor at Cowboy Ventures, was so alarmed by the loans that he published a blog post in 2014, “Playing With Fire,” advising against them for most individuals. Mr. Wang said he got a fresh round of calls concerning the loans anytime the market overheated and at all times felt obligated to elucidate the risks.

“I’ve seen this go incorrect, bad incorrect,” he wrote in his blog post.

Start-up loans stem from the way in which staff are typically paid. As a part of their compensation, most employees at privately held tech corporations receive stock options. The choices must eventually be exercised, or bought at a set price, to own the stock. Once someone owns the shares, she or he cannot normally money them out until the start-up goes public or sells.

That’s where loans and other financing options are available. Start-up stock is used as a type of collateral for these money advances. The loans vary in structure, but most providers charge interest and take a percentage of the employee’s stock when the corporate sells or goes public. Some are structured as contracts or investments. Unlike the loans offered by Bolt, most are often known as “nonrecourse” loans, meaning employees should not on the hook to repay them if their stock loses its value.

This lending industry has boomed lately. Most of the providers were created within the mid-2010s as hot start-ups like Uber and Airbnb delay initial public offerings of stock so long as they might, hitting private market valuations within the tens of billions of dollars.

That meant lots of their staff were sure by “golden handcuffs,” unable to depart their jobs because their stock options had grow to be so beneficial that they might not afford to pay the taxes, based on the present market value, on exercising them. Others became uninterested in sitting on the choices while they waited for his or her corporations to go public.

The loans have given start-up employees money to make use of within the meantime, including money to cover the prices of shopping for their stock options. Even so, many tech staff don’t at all times understand the intricacies of equity compensation.

“We work with supersmart Stanford computer science A.I. graduates, but nobody explains it to them,” said Oren Barzilai, chief executive of Equitybee, a site that helps start-up staff find investors for his or her stock.

Secfi, a provider of financing and other services, has now issued $700 million of money financing to start-up staff because it opened in 2017. Quid has issued a whole lot of tens of millions’ value of loans and other financing to a whole lot of individuals since 2016. Its latest $320 million fund is backed by institutions, including Oaktree Capital Management, and it charges those that take out loans the origination fees and interest.

To date, lower than 2 percent of Quid’s loans have been underwater, meaning the market value of the stock has fallen below that of the loan, said Josh Berman, a founding father of the corporate. Secfi said that 35 percent of its loans and financing had been fully paid back, and that its loss rate was 2 to three percent.

But Frederik Mijnhardt, Secfi’s chief executive, predicted that the subsequent six to 12 months might be difficult for tech staff if their stock options decline in value in a downturn but they’d taken out loans at the next value.

“Employees might be facing a reckoning,” he said.

Such loans have grow to be more popular lately, said J.T. Forbus, an accountant at Bogdan & Frasco who works with start-up employees. An enormous reason is that traditional banks won’t lend against start-up equity. “There’s an excessive amount of risk,” he said.

Start-up employees pay $60 billion a 12 months to exercise their stock options, Equitybee estimated. For various reasons, including an inability to afford them, greater than half the choices issued are never exercised, meaning the employees abandon a part of their compensation.

Mr. Forbus said he’d needed to rigorously explain the terms of such deals to his clients. “The contracts are very obscure, they usually don’t really play out the mathematics,” he said.

Some start-up staff regret taking the loans. Grant Lee, 39, spent five years working at Optimizely, a software start-up, accumulating stock options value tens of millions. When he left the corporate in 2018, he had a selection to purchase his options or forfeit them. He decided to exercise them, taking out a $400,000 loan to assist with the associated fee and taxes.

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. That meant the stock options held by employees at the upper valuation were value less. For Mr. Lee, the worth of his Optimizely stock fell below that of the loan he had taken out. While his loan was forgiven, he still owed around $15,000 in taxes since loan forgiveness counts as taxable income.

“I got nothing, and on top of that, I needed to pay taxes for getting nothing,” he said.

Other corporations use the loans to offer their staff more flexibility. In May, Envoy, a San Francisco start-up that makes workplace software, used Quid to supply nonrecourse loans to dozens of its employees in order that they could get money then. Envoy, which was recently valued at $1.4 billion, didn’t encourage or discourage people from taking the loans, said Larry Gadea, the chief executive.

“If people imagine in the corporate and wish to double down on it and see how significantly better they’ll do, that is an important option,” he said.

In a downturn, loan terms may grow to be more onerous. The I.P.O. market is frozen, pushing potential payoffs further into the longer term, and the depressed stock market means private start-up shares are probably value lower than they were during boom times, especially within the last two years.

Quid is adding more underwriters to assist find the correct value for the start-up stock it lends against. “We’re being more conservative than now we have up to now,” Mr. Berman said.

Bolt appears to be a rarity in that it offered high-risk personal recourse loans to all its employees. Ryan Breslow, Bolt’s founder, announced this system with a congratulatory flourish on Twitter in February, writing that it showed “we simply CARE more about our employees than most.”

The corporate’s program was meant to assist employees afford exercising their shares and cut down on taxes, he said.

Bolt declined to comment on what number of laid-off employees had been affected by the loan paybacks. It offered employees the selection of giving their start-up shares back to the corporate to repay their loans. Business Insider reported earlier on the offer.

Mr. Breslow, who stepped down as Bolt’s chief executive in February, didn’t reply to a request for comment on the layoffs and loans.

In recent months, he has helped found Prysm, a provider of nonrecourse loans for start-up equity. In pitch materials sent to investors that were viewed by The Latest York Times, Prysm, which didn’t reply to a request for comment, advertised Mr. Breslow as its first customer. Borrowing against the worth of his stock in Bolt, the presentation said, Mr. Breslow took a loan for $100 million.

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