We have written extensively about why startups are staying private longer and how it represents a wealth generation shift from public to private markets.
Besides market forces, regulation has also played an important role in startups remaining private longer. Before the 2012 JOBS Act, startups could only have 500 investors on their cap table. Since startups’ employees could exercise their options and sell their shares on the secondary market, the startups’ ownership numbers went through the roof, forcing them to go public in order to comply with the rule. After the act’s passage, the number increased to 2,000 (excluding option holders), which made the cap tables much more manageable.
Even after this # increase, every startup uses transfer restrictions into their option plans, which limits an employee’s ability to sell their shares unless approved. Such restrictions help keep the cap tables clean and more in control of who owns shares.
Options have been the most common stock-based compensation in startups. However, Restricted Stock Units (RSUs) have gained popularity.
Stock options provide employees with the right but not the obligation to acquire shares of the startup at a specified price. RSUs, on the other hand, are awarded outright on a set series of dates over several years. Thus, at the vesting dates, the employee must pay taxes — the entire value of an employee’s vested stock is counted as ordinary income in the year of vesting. Moreover, the typical options’ duration is 10 years, while for RSUs is 5-7 years (cliff modality).
RSU became a trending topic last week. Given that the IPO window is closed (10x revenue is not appealing for tech SaaS startups), Stripe — founded in 2010 in SF, and one of the most valuable startups (valuation of $95B in March 2021) — is considering a $4B down round in order to appease the early RSU holders.
Worried by the expiration pressure on options / RSUs holders, the SEC is now considering some reversing changes in the 2012 JOBS Act in order to speed-up IPOs. One of the proposed changes could be the counting of each individual investor in SPVs – if approved, the result would be a farewell to club deals.
Employee retention and recruitment remain a top priority for the leading startups.
Thus, liquidity solutions for options / RSUs holders will continue to be on the agenda of Late Stage startups, which is great news for Fabrica Ventures Fund II.