Borrowing If You Own Startup Stock
TL;DR Owners of startup stock can buy a home, pay off debt, or make other big purchases using several forms of borrowing. Successful borrowers focus on reducing costs and levering non-private assets if you have them, and a tailored financial plan.
Why would I want to borrow?
Borrowing is a way you can gain better control of your financial outcomes, especially if you borrow with a financial plan in mind. Borrowing can help you “unlock your balance sheet” by making cash available today, enabling you to make a large purchase without selling shares that you believe will increase in value, and creating liquidity without incurring taxes from selling shares. While borrowing might sound risky, it can be cost-effective and may often be the best long term financial plan.
Who should borrow?
While each situation is unique, these are a few common scenarios where borrowing would be a smart financial decision:
Example 1: I am a Series C co-founder and my balance sheet is $20M of restricted stock. $200,000 of liquidity now (1% of my private stock) could unlock a more satisfying rental apartment, a downpayment on my first home, or otherwise settle my personal needs for the coming 12-30 months of our company's growth.
Example 2: I own stock in several public companies and am a Series D engineering manager who joined at my current company’s Series B. I exercised my grants early and have some liquid investments in crypto and tech stocks. I want to pay off my final $100k of student debt. Borrowing $100k from my investment account allows me to pay off my student loans at lower interest rates, and is a key accomplishment for me personally.
Example 3: I work at a startup and am fully vested in my initial equity grants. I’m now looking to move on to a new company after four and a half years. I’ve exercised about half of my options and now have a limited time to exercise the remaining options before they expire. Liquidity would enable me to make a move and take advantage of this highly lucrative position.
Example 4: I am an employee at a Series E company with a tender offer program that is available to vested equity holders. Freeing up liquidity gives me the choice of exercising more unvested shares with a multi-year strategy to start the long term capital gains clock on these shares as they vest.
Example 5: I am family-focused and need to buy a home after renting for years. I have never made a large purchase and my spouse and I have built a suitable credit rating for purchasing a home. I know startup equity isn’t great collateral for a mortgage, but our income has been consistent for a year and we need more liquidity now as we think about starting a family.
What are the risks of borrowing?
The biggest risk of borrowing for you and your lender is the chance for you to fail to repay your loan.
All lenders minimize their risk by seeking multiple forms of repayment, such as two types of assets, or one asset plus large income. Unfortunately, private stock (even in the best Series A or B companies) is rarely seen as a source of repayment until there is a robust market for selling the position. So, banks regard a borrower with private stock and no liquidity (no cash in a bank account, a modest salary, no securities account) as an underwriting risk.
Therefore, borrowers need to consider the timing of their need, and ask: Is now the right time to borrow, or should I wait until later? You should wait to borrow if your profile is entirely illiquid. Lenders will see you as a repayment risk, and at best, you’ll receive below-market terms and conditions. Instead, if you have limited liquidity and are considered by lenders to be a higher risk borrower, the best thing you can do is plan ahead and prepare for borrowing. That might mean holding off until you have a tender offer or waiting for an upcoming bonus. Many borrowers with startup stock also explore non-traditional sources of liquidity (such as loans from family) and choose to stay illiquid months longer than originally planned to reduce their repayment risk and qualify for a loan on more favorable terms.
How do I borrow?
Once you decide you are ready to borrow, start by creating a simple plan to define your exact need. (i.e. Buying a home by the due date of a child, or exercising options before a calendar year-end.) You can control the factors of borrowing by anchoring your personal need for available cash to a plan.
A fiduciary advisor can help you determine the optimal strategy (e.g. a bank loan, a private equity solution, securities-based line of credit, etc.) for reaching your goals. A fiduciary has a duty to act in the best interest of their client. (Compound can act as your fiduciary to perform advanced work with your plan and potential financial partners.) We will share more about financial partners later in this piece.
If you prefer to work independently, expect a significant amount of upfront work and ongoing administrative tasks. There are more tools to help on the front-end than ever before but the same administrative burden remains. Be prepared for dozens of calls, emails, portals, random requests, and a multi-week timeline for execution. Home loans will require tax returns, W2s, account statements, and pay stubs.
Put your plan into action and gauge tradeoffs using the simple framework below.
First, determine a range (minimum and maximum) for:
- Dollar amount you need
- Time frame for when you will need the funds
- Conditions associated with the loan (example: you will sell no more than 5% of your company stock, or you must buy a house within a specific zip code)
Then, ask yourself the following questions:
1. How specific is my need? If you just want options for liquidity, be open to more than one choice, and consider each in the context of your long-term financial plan. For example, a prepaid forward contract may make sense for your friend who has no home equity to borrow against, but a Home Equity Line Of Credit (HELOC) is more appropriate if you have available home equity as HELOCs are nearly always cheaper. Most borrowers will use more than one loan product in their first few years using loans.
2. Am I price sensitive? If not, you’ll prioritize certainty now at a higher price rather than selecting potentially uncertain market conditions later. If yes, you’ll seek to minimize fees, points, and interest rates. Specific types of financial products open liquidity immediately:
- The most commonly used tool by our clients is a securities loan called a secured Portfolio Asset Line of Credit (PAL) linked to a brokerage account with publicly traded assets. Startup founders and employees tend to prefer this loan because its rates are lower than most other forms of borrowing, and the terms for borrowing are borrower-friendly.
- Home financing is nearly as common because rates are more favorable when compared to many other loans. Home financing starts with a first mortgage to buy or refinancing a current mortgage.
- Less common but very valuable in specific credit needs is an unsecured line of credit. Uses include exercising stock options, down payment on a home, etc.
3. Do I need money now or later? Some people choose to unlock their balance sheet now and wait until later to tap that liquidity. For example, you can open a PAL or HELOC today, but use it months or years in the future. This strategy enables them to plan ahead while waiting to optimize around future events, such as a large tax payment due, a new tax year, or a new grant of ISOs/NSOs.
4. Finally, make sure you understand the answer to these three key questions:
- When will I repay this loan, and how?
- Am I satisfied with the terms, conditions and consequences of borrowing?
- Is this loan amount ample liquidity?
Note: You’ll want to use a traditional loan from a bank when and where you can. A traditional loan is often the cheapest and least risky option because they have the most favorable underwriting terms. However, they can be complicated because they’re personal. You may have heard stories from friends or colleagues who took out big loans from banks, but the best choice for you may be different based on your particular situation.
Who can I borrow from?
With your borrowing decision clarified using the framework above and a borrowing plan in hand, you’re ready to connect with a financial partner who you can borrow from.
Financial partners often come in one or more of the four following forms:
- Your employer may hold what’s called a company tender offer, which is an offer to some cohort of shareholders that provides an opportunity to sell their shares for a set price per share. Most companies infrequently hold tender offers (once every couple of years), and generally restrict them to current employees who’ve reached some level of tenure. Deciding whether or not to participate in the tender offer has trade-offs—every share you sell is potentially worth more (but may also be worth less) in the future. Note: this is selling equity, and although technically not borrowing, this has become an increasingly more common form of liquidity for early employees with vested stock.
- Banks want to be repaid on time and in full, so they prefer to lend to borrowers who have higher income, larger liquid assets, and specific time frames for repayment. However, some more “tech-friendly” banks may cater to founders or startup employees in order to win their startup’s banking business. These include Metropolitan Capital, First Republic Bank, and SIlicon Valley Bank.
- Private equity funds specializing in secondary liquidity will often offer an interest rate and non-recourse terms which can allow the borrower to defer taxes, with a stock fee (percentage of the shares lent against) as an additional cost. The combined terms generally make this liquidity option more expensive than most forms of bank financing. Private equity funds include 137 Ventures, Founder Circle, Quid, SecFi, etc.
- Brokerages hold stocks, bonds, mutual funds and exchange traded funds (ETFs) in brokerage accounts, and allow for tax-deductible loans against these assets. These brokerage loans, PAL and Margin Lines, come with favorable terms and interest rates because brokerage assets are the collateral, and are easily saleable in case the terms of the loan are violated. These loans are not offered against private stock or stock options. PAL and Margin Lines are offered by Charles Schwab, Goldman Sachs, etc.
With plentiful cheap credit available today, borrowing is easier and more favorable now than ever before for startup employees and founders. Benefits to borrowing include accessing liquidity without selling equity or incurring taxes, and providing the financial stability you need to achieve your short- and long-term goals. Planning ahead and evaluating the tradeoffs can help you take control of variables including your needs, timing, and available products to achieve liquidity. If borrowing feels daunting, this could be a sign to contact a trusted financial partner who can help you work through your plan. Contact your Financial Advisor to learn more.
Our next guide will dive into the different tradeoffs you should weigh when choosing a financial partner. It will include key risks to consider and what you can do to get the best rate.
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