Stock-Option Financing in Pre-IPO Companies

Abstract

In this Closer Look, we examine a new industry that has arisen in recent years to facilitate the financing of stock-option exercises for employees and executives of pre-IPO companies. These capital providers allow individuals to exercise and retain their stock option awards, meaning the employee can continue to participate in any future appreciation of the shares while still receiving the money needed to exercise the award, pay taxes, and in some cases extract additional capital to finance personal expenditures. We consider the economic implications of this market from the perspectives of employees and employers, as well as the financial model of the capital providers that participate in this space.

We ask:
• For which employees does stock-option financing make sense?
• Is the growth of this industry driven by large increases in private company valuations, or would it continue in the absence of these forces?
• Why haven’t more traditional lenders entered the market? Would more competition drive down lending rates and the returns these vendors enjoy?
• What impact does early exercise of stock options have on incentive programs?

Keywords: Corporate governance, stock options, ISOs, NSOs, stock option financing, nonrecourse lending, pre-IPO companies, private companies, startups, secondary markets, taxes, equity compensation, employees, executives, incentives, corporate governance research