Free Leverage and Diversification

Get an Advance from ESO to Exercise your Stock Options

For people who work in private, venture-backed companies, stock options may represent the most potentially valuable asset they have. Note that key word—potentially.

But stock options aren't a sure thing. For every private company that goes public or is sold for high price, many more are liquidated and the people who own common stock or exercised their options lose 100% of their investment.

This leverage isn't actually free but it is conceptually free because ESO advances are non-recourse

If you exercise your private company stock options with your own money, then you have 100% of your investment concentrated into a single, illiquid investment. If you let ESO make the investment for you and you invest your money into something else, you still have the majority of the financial benefit of your private stock plus the full value of the other investment. By doing so, you have not only diversified your investment but you've actually made it more valuable than what it was. Technically, your net worth has increased through leverage.  This leverage isn't actually free but it is conceptually free because ESO advances are non-recourse. Even if the private stock collapses to zero value, you still have 100% of your other investment. Normally, leverage can not only amplify your asset value but it can amplify your losses as well. This happens because most loans are recourse loans. For example, auto loans and home equity lines of credit are recourse loans that you must pay back even if you lose the money by making an unsuccessful investment. This won't be the case with an ESO advance against your private company stock.

Investing Your Own Money
  • You Cover $50,000 Option Exercise
  • You Cover $10,000 Taxes
  • You get 100% of Stock Value at Exit
  • Assume Chance of Successful Company Exit is 50%
  • Hold for 3 years
  • You Invest $0 to Reduce your 3% Mortgage
Expected Final Value = 50% of your Stock's Exit Value
Letting ESO Invest For You
  • ESO Covers $50,000 exercise
  • ESO Covers $10,000 Taxes
  • You get 65% of Stock Value at Exit (ESO Takes 35%*)
  • Assume Chance of Successful Company Exit is 50%
  • Hold for 3 years
  • You Invest $150,000 to Reduce your 3% Mortgage
Expected Final Value = 32.5% (50% of 65%) of your Stock's Exit Value + $163,500 additional equity in your home ($150K at 3% interest for 3 years)
Whether it is better to invest your own money or let ESO make the investment ultimately depends on whether 17.5% of the stock's exit value is more valuable than the $163,500 of extra cash benefit. The difference of 17.5% (50% – 32.5%) of stock value equates to how well $26,250 (17.5% of $150K) of your original $150K investment performs. To match the guaranteed return of $163,500 from simply reducing your mortgage, it would have to yield an ROI of 6.2x. According to Cambridge Associates as of Sept. 30, 2016, the best performing vintage year ever recorded for venture capital and private equity was 1991 where upper quartile funds achieved an ROI of 3.54x and median funds achieved 2.44x.** Moreover, their average time to exit was considerably longer than 3 years for early stage companies. As such, your particular circumstance would have to be significantly above average to justify carrying the additional personal risk.
*All offers are individually tailored and these numbers are for the purpose of example only. Although 35% of total proceeds is typical for ESO clients, your actual cost by percentage is unknown until final liquidity is achieved.
**These figures are from the Cambridge Associates U.S. Private Equity & Venture Capital Index and Benchmark Statistics as of September 30, 2016. The industry results are reduced by fund manager fees and based on actual success rates that can be quite different from 50%.

Now there is a choice that allows option holders to obtain upside with minimal risk—obtain an advance from the ESO Fund and use that money to exercise your options. No repayment is due unless and until there is a liquidity event involving the company that issued the shares, such as a sale or IPO. ESO can also advance funds for potential tax liabilities associated with the stock, such as Alternative Minimum Tax (AMT). Even if you can afford to exercise your options and pay your AMT, by leveraging ESO's funding you can diversify your risk by investing in other assets instead. The combination of equity in your startup company purchased with ESO's help and the assets you invest in directly can represent a safer and larger portfolio than if you merely invested in a single company.

An advance from ESO to exercise your options can provide you with significant upside with minimal risk. If you'd like to know more about how ESO can help your financial situation, please contact us.

This innovative service promotes and enables a healthier relationship between companies and employees. I my opinion it's valuable to employees and great for the overall tech environment and economy. It is good for nobody when employees feel trapped because they can't afford to leave. In less extreme cases exercising can be expensive and somewhat risky and this is simply a good smart hedge and a good square deal. Brilliant!

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