When Facebook and Twitter delayed their IPO timelines after the recession, their employees found themselves wealthy on paper, but with no way to monetize it. This dilemma gave rise to the first iteration of the secondary market, as cash-poor shareholders in high-flying tech companies began to search out investors to buy their stock. With marketplaces proliferating to connect shareholders and interested investors, companies began to take control of the situation by offering certain shareholders—mainly employees—a chance to sell their stock through company- sponsored tender offers.

While many employees will still seek out secondary markets, several companies discourage or outright block sales. Even if an employee can sell, they are often more focused on tax planning and would prefer to exercise and hold at least part of their option grant, assuming they had the cash to do so. Enter the option lending market. Like the secondary market before it, option lending has evolved rapidly over the past several years. The market gained momentum from to , with lenders providing capital to employees that were leaving their current company and who had a limited amount of time to exercise their options and pay any taxes associated with the exercise.

Stock Options And Non-Recourse Loans - Employment and HR - United States

As the lending market picked up steam on the back of these expiring option grants, ever-increasing valuations opened up an opportunity for those same lenders to help shareholders that were getting high-priced options in these newly minted unicorns. As those holders began to look around for ways to exercise their stock and kick off the capital gains clock, the emerging lending market started to become an attractive option. Unlike shareholders in public companies who can go to almost any bank and receive a loan for their stock, holders of private stock and options have far fewer opportunities.

Currently, there are two distinct and growing groups of banks and funds that are willing to lend against your private company stock. The first group of more traditional bank lenders typically charge a fixed interest rate on a loan and use your stock as collateral. The second tranche of lenders are typically structured as funds, and they offer loans that combine fixed interest and upside. In these structures, you are required to pay back the interest and hand over a certain percentage of your stock or proceeds from the stock at the time you gain liquidity e.

These structures tend to vary and every fund has their own preferred methodology, but one similarity across all the funds is that they remove the personal recourse requirement. This usually means that the shareholder is only putting up their stock as collateral and not their other assets. While the lending market continues to grow rapidly thanks to recent market conditions, shareholders should still be thoughtful about deciding to take out a loan against their stock. The terms of the loan can be complex, and if personal recourse is involved, you must be thoughtful about the size of the loan and what type of risk you are willing to bear if the stock declines.

If you have questions, you should seek out legal advice and fully understand the risks before signing on the dotted line. This could be the largest financial transaction you have ever completed, so it pays to be thoughtful and weigh all the possible outcomes before diving in headfirst.

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As the private market continues to evolve, more options will become available to help shareholders gain liquidity. Every private company shareholder should think through the implications of exercising, selling or lending against their stock to make sure they pick the best path for their personal success. For private companies that need help navigating the complex landscape of equity management, the Shareworks by Morgan Stanley team is excited to continue serving as a resource. The lifecycle of a private company is evolving.

Over the last two decades, the timeline for companies to s Learn about IPO lockout periods, insider selling and see how Shareworks can support your journey to going public.

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See how to improve employee retention, attract top talent and boost employee productivity with a tender offer. Discover how Shareworks can make your liquidity event easier with tender offer and stock buyback tips. Learn about tender offers, when to perform a tender offer buyback and more about this liquidity event. This practice has become a popular method for exercising options among employees who are eligible to participate in employee stock option plans ESOPs.

It is most common among publicly traded companies , due to their greater liquidity. Most private companies cannot accommodate a cashless exercise, because they have insufficient liquidity. However, they may be able to achieve similar results by using other mechanisms, such as by issuing promissory notes , which are similar to the loan a broker would provide in a regular cashless exercise. Emma works for XYZ Corporation, and over the years she has accumulated a substantial amount of stock options.

Moreover, there are also taxes and brokerage fees that would add to the initial cost of exercising the options, even though it would lead to a profit in the end.

Stock Option Lending: The Fastest Growing Market in the Private Company Liquidity Toolbox

To solve this problem, her employer offers a cashless exercise plan. Using this loan, she exercises her options and buys 5, worth of stock.

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Proceeds from such an exercise would receive favorable tax treatment provided that a few conditions are met, such as whether the employee has held the shares for at least one year from the exercise date and two years from the grant date. If those requirements are not met, the proceeds would then be treated as ordinary income.

What happens to stock options after an IPO?

In the real world, this transaction would be handled by the broker on behalf of Emma. From Emma's perspective, the money from the sale of the options would only arrive in her account after the loan from the broker and the associated fees have been repaid.

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We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. What Is a Cashless Exercise? Key Takeaways A cashless exercise transaction involves using a broker to facilitate the sale of stock options by employees. It is designed to allow employees to exercise their options even if they do not have the resources to make the upfront purchase of shares.

Cashless exercises are popular among employees of publicly traded corporations, and can receive favourable tax treatment under some conditions. Compare Accounts.