Secfi's 2021 State of Stock Options Equity Report

Record-Breaking Public Exits in 2021

The previous year witnessed an unprecedented surge in companies becoming publicly traded. A total of over 844 U.S. businesses launched onto the stock market through initial public offerings (IPOs), direct listings, or special purpose acquisition companies (SPACs).

This figure represents a substantial increase of 105% compared to the 410 companies that went public in 2020, as reported by PitchBook.

Significant Value Generated for Employees

The 20 largest U.S. IPOs collectively created an estimated $41 billion in pre-tax value for employees holding stock options within those organizations.

While heightened public exit activity benefits founders and investors, the implications for employees with vested stock options are also considerable.

Analyzing Employee Stock Option Trends

An in-depth analysis was conducted, utilizing both proprietary data and filings with the U.S. Securities and Exchange Commission. This investigation aimed to identify key trends impacting employees of late-stage unicorns throughout 2021.

The findings of this research are summarized below:

Key Findings Regarding Stock Option Exercise

• Approximately $11 billion in potentially avoidable taxes were paid by startup employees in 2021. This occurred because they exercised their stock options *after* the exit, instead of prior to it.
• Secfi clients, on average, incurred costs of $543,254 to exercise their pre-exit stock options during 2021.

Taxes constituted roughly 73% of this total expense, often exceeding annual household income.

Savings Achieved Through Pre-Exit Exercise

Employees at companies that completed an IPO in 2021 realized average savings of nearly $415,000 by exercising their stock options *before* the IPO.

Variation in Exercise Rates

The rate at which employees exercised their stock options before an exit varied significantly between companies.

Rates ranged from a low of 2.4% to a high exceeding 77%, potentially reflecting differing levels of employee confidence in their respective companies’ future performance.

$11 Billion in Excess Taxes Paid in 2021

An estimation by Secfi indicates that employees of U.S. startups backed by venture capital, which became publicly traded in 2021, collectively paid approximately $11 billion in avoidable taxes.

This higher tax burden stemmed from delaying the exercise of their stock options until after the company’s public offering. Exercising options prior to the exit event could have resulted in a lower overall tax liability.

Potential Benefits of Early Exercise

Exercising stock options before a company goes public isn't just about tax savings. It also presents an opportunity to potentially increase profits realized from subsequent share sales.

Throughout 2021, the substantial costs associated with exercising stock options presented a significant obstacle, preventing many employees from taking advantage of early exercise opportunities.

• Early exercise can minimize tax obligations.
• It can maximize potential gains upon selling shares.

The analysis by Secfi was based on data from 172 U.S.-based, venture capital-funded companies that completed public exits in 2021.

The Financial Implications of Exercising Stock Options in 2021

Data from Secfi indicates that the average cost to exercise stock options reached $543,254 in 2021. This figure is approximately double the average annual household income of Secfi clients, which stood at $270,000.

Significant exercise expenses remain a substantial challenge for employees working at startups. This is a primary driver behind instances where employees are compelled to relinquish their stock options upon departing a company.

Alternatively, some employees choose to exercise their options following a company's initial public offering (IPO) through a process called a cashless exercise.

Cashless exercises are subject to the maximum possible tax rate and lead to substantial short-term capital gains tax liabilities for startup employees. These taxes could have been avoided had the options been exercised while the company was still privately held.

Understanding the Impact

The financial burden of exercising options often forces difficult decisions for startup personnel. Exercising options requires substantial capital outlay.

Consequently, many individuals are left with limited choices, potentially missing out on significant wealth-building opportunities. The implications of these financial constraints are far-reaching.

• Forfeiting options represents a lost potential asset.
• Cashless exercises maximize tax obligations.
• Exercising while private could offer tax advantages.

Collectively, startup employees are paying billions of dollars in taxes that could have been mitigated through proactive option exercise strategies. This highlights the need for better financial planning and access to resources.

The Tax Burden Constitutes 73% of Stock Option Exercise Expenses

Estimates from Secfi indicate that in 2021, taxes accounted for almost 73% of the overall expense associated with exercising stock options for their clientele.

This highlights a significant financial consideration for individuals with stock options. The tax implications often represent the largest portion of the total cost.

Understanding the Cost Breakdown

Exercising stock options isn't simply about the strike price. A substantial portion of the financial outlay is dedicated to fulfilling tax obligations.

Secfi’s analysis of 2021 data demonstrates the considerable impact of taxes on the overall expense of option exercises.

The data underscores the importance of careful financial planning when considering stock option exercises.

Individuals should proactively assess the potential tax liabilities to accurately determine the net financial benefit of exercising their options.

Stock Options: A Significant Financial Choice

For a large number of individuals, the act of exercising stock options represents one of the most substantial financial choices they will encounter.

This decision often carries significant weight, comparable to other major life investments.

Financing Major Life Events

Typically, Americans utilize financing to cover considerable expenses. These include purchases like vehicles, funding higher education, and acquiring homes.

However, comparable financing solutions for startup stock options are not widely available.

The Current Landscape

The majority of American employees currently lack access to dedicated financing programs specifically designed for their stock options.

Consequently, individuals are often required to explore alternative methods to cover the costs associated with exercising these options.

This situation highlights a gap in the financial resources available to employees holding equity in startup companies.

Potential Tax Benefits of Pre-Exit Option Exercise: $414,890 Average Savings

During 2021, a significant number of startup employees leveraged Secfi’s specialized resources and calculations to gain clarity regarding their equity positions.

Analysis of this cohort – encompassing both those who secured funding through Secfi and those who did not – revealed that individuals who exercised their options prior to an exit, thus qualifying for long-term capital gains rates, realized an average tax savings of approximately $415,000.

This represents a substantial difference compared to those who opted for cashless exercises following the exit, and were subsequently subject to short-term capital gains taxes.

Extrapolating these findings to the broader market, Secfi data indicates that employees who proactively exercised their stock options before an exit in 2021 collectively saved an estimated $2.4 billion in taxes.

This savings was achieved by capitalizing on the more favorable long-term capital gains tax rates applicable when selling the shares.

Key Findings from Secfi’s 2021 Equity Report

• Pre-exit exercise allows for potential long-term capital gains tax treatment.
• Cashless exercises post-exit typically result in short-term capital gains taxes.
• Significant tax savings can be realized by exercising options before a company exits.

The data underscores the financial advantages of understanding and strategically managing stock options before a liquidity event occurs.

The expense of exercising stock options can increase by 3,360% from seed to Series C

Typically, the cost an employee incurs when exercising their stock options experiences a substantial rise as the startup progresses through successive funding rounds. This increase is generally correlated with the company’s growing valuation.

Consider the following illustration, detailing the projected cost to exercise $10,000 in incentive stock options at various stages of funding, based on average valuation growth observed in 2021.

Stock Option Exercise Rates Prior to Company Exits in 2021

The decision by an employee to exercise their stock options before a company's exit is a clear indication of their belief in the company’s future success. Analysis of S-1 filings from 20 of the largest initial public offerings (IPOs) of 2021, ranked by market capitalization, reveals a significant range in pre-exit exercise rates.

Some organizations witnessed over 75% of vested stock options being exercised by employees prior to the exit. Conversely, other companies experienced exercise rates as low as 2% before becoming publicly traded.

Financial Risks and Employee Hesitation

Exercising stock options involves inherent financial risk for employees. A lack of a successful exit, or a flat exit resulting in no gains, could lead to financial loss.

Consequently, employees with doubts about their company’s potential may prefer to postpone exercising their options until after the exit, allowing the market to establish a valuation for the company’s shares.

Factors Influencing Exercise Rates

Insufficient employee education regarding the benefits of pre-exit exercise can also contribute to lower rates.

The prevailing investment climate, characterized by high pre-exit valuations, can make exercising options financially challenging, particularly for employees joining companies close to an IPO.

• High valuations increase the cost of exercising.
• Employees may lack the capital to cover exercise costs and taxes.

These factors can collectively impact an employee’s willingness to exercise their stock options before a company goes public.

Stock Option Forfeiture Rates Prior to IPOs in 2021

In 2021, as several startups prepared for initial public offerings (IPOs), a notable trend emerged: a significant number of employees proactively relinquished their stock options.

This took the form of either departing the company and consequently forfeiting unvested options, or choosing not to exercise options that had already vested.

An Alternative Gauge of Employee Confidence

Analyzing S-1 filings from companies like Coinbase, Applovin, Affirm, TuSimple, and Compass reveals that this behavior can be interpreted as a distinct measure of employee confidence.

Employees might be more inclined to forego their current stock options if they anticipate acquiring more valuable equity opportunities at other organizations.

Potential Indicators of Underlying Issues

Elevated forfeiture rates could also signal issues within the company.

These may include a high rate of employee attrition leading up to the IPO, or insufficient guidance provided to employees regarding the benefits and mechanics of their stock options.

• High turnover can lead to more unvested options being left behind.
• A lack of education can result in employees not understanding the value of exercising their vested options.

Understanding these factors is crucial for assessing the overall health and stability of a company prior to becoming publicly traded.

The Impact of Public Exits on Startup Employee Wealth

A significant surge in U.S. public company exits occurred in 2021, creating substantial wealth – amounting to tens of billions of dollars – for employees holding stock options.

However, the financial burden associated with exercising these options often prevented employees from doing so before the exit occurred.

The Challenge of Exercising Stock Options

Due to the considerable expense of exercising stock options, a large proportion of employees at companies that went public in 2021 were unable to capitalize on their equity until after the exit event.

This delay resulted in billions of dollars in potentially avoidable tax liabilities.

Future Trends and Rising Costs

Current industry patterns, characterized by larger funding rounds and extended timelines to exit, suggest that the cost of exercising stock options will likely increase for the typical startup employee.

Consequently, taxes will likely continue to pose a significant obstacle to employees gaining ownership of their equity prior to a public offering or acquisition.

Stock Option Exercise as a Performance Indicator

Preliminary data indicates that the rates at which employees exercise their stock options before an exit, and the rates at which they forfeit those options, could serve as a valuable, yet often overlooked, metric for predicting a company’s post-exit share price performance.

Further investigation into this correlation is warranted.

Key Takeaways

• 2021 witnessed a record number of U.S. public exits.
• These exits generated substantial wealth for startup employees.
• High exercise costs often delayed option exercise until after the exit.
• Rising costs and longer timelines may exacerbate this issue.
• Pre-exit exercise and forfeiture rates may indicate future share performance.