- The Employee Stock Option, or ESO, Fund, which is based in Silicon Valley, offers a way for startup workers to exercise their stock options in exchange for a cut of the shares when the startup goes public or is acquired, plus fees and interest.
- ESO Fund’s financing are non-recourse loans. In other words, the firm takes on all the risk. If your options end up not being worth much because of a disappointing IPO or if they become worthless because the startup goes out of business, you wouldn’t have to pay back the money.
- ESO Fund has helped clients exercise stock options worth as little as $1,500, and has funded major deals worth a few millions, founder Scott Chou told Business insider. “A median transaction is probably $55,000,” he said.
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I took a brief break from journalism to work for a couple of startups. That meant getting some stock options, which gave me the right to buy shares of a new company at low prices, before it went public or got acquired.
But when I left these firms I found myself wrestling with the typical dilemma faced by startup employees. I didn’t have the cash to exercise my vested options. And once I left the company, I had roughly 90 days to do so — or give them up.
That’s what happened at the first startup. I was about to walk away from my options with the second startup when I came across a Silicon Valley firm that helps employees of venture-backed startups exercise their options.
The Employee Stock Option, or ESO, Fund, which is based in Foster City, gives startup employees access to funds they need to exercise vested options, in exchange for a percentage of their shares plus fees and interest.
Exercising options is risky business
Other firms, such as Shares Post and Nasdaq Private Market, also offer ways for startup employees to sell their exercised options, typically through the companies that issued them. But these firms do not offer individual financing for exercising options.
What made ESO Fund compelling to me was that it offers what is a essentially a non-recourse loan, which is a fancy way of saying it takes on all the risk. If your options end up not being worth much because of a disappointing IPO or if they turn out to be worthless because the startup goes out of business, you wouldn’t have to pay back the money.
“Because we’re non-recourse, we’re essentially free leverage,” ESO Fund co-founder Scott Chou told Business Insider.
Zero leverage was exactly what I was looking for. Now, I wasn’t a hotshot executive, manager or engineer so we’re not talking about options that would have made me a millionaire. But I thought the proceeds certainly could help offset my kids’ college costs and pay down some credit card debt.
But I didn’t have the extra cash and was not willing to go deeper into debt to exercise my options. Also, I didn’t really have any appetite for the risk involved.
With ESO Fund, I didn’t have to dip into our family savings or take out a personal loan to cover the options and the taxes I’d have to pay for exercising them. And I wouldn’t have to worry about the risk that the investment might fail.
But it’s a tradeoff.
I’d still have to wait for the startup to go public or be acquired, but if it ends up with a gangbusters IPO or gets acquired at a hefty price tag, I’d have to share a sizeable chunk of the proceeds with ESO Fund. Which is fine with me since ESO Fund did take on all the risk.
Typically, ESO takes roughly 30% of the proceeds, though it can vary depending on the startup.
It was an alternative that paid off handsomely for Shariq Minhas, an engineer who once was employed by a ride-sharing startup that went public recently. He had left before the company’s IPO.
“I didn’t have money to do the early exercise of the stock options,” he said. “There was significant money on the table.” He found it hard to accept that he may just have to simply walk away, he said: “You’re screwed. You’d have nothing to show for all those years of work.”
He decided to sign with ESO Fund which provided him with the roughly $400,000 he needed to exercise his options and to cover the sizeable tax burden related to the exercise.
“It was a no-risk proposition,” he said. “ESO Fund was taking all the risk over here by fronting the money. They have no recourse. If the company goes under, they don’t get any of the money back.”
But ESO Fund did get its money back — and more.
The ride-sharing company went on to have a solid IPO which was great news for Minhas — and for ESO Fund. Minhas estimated that ESO Fund made roughly $800,000 on the transaction.
In a way, that’s money Minhas gave up because he opted to work with ESO Fund, he said. But then again, he didn’t have to come up with the dough for the options and the taxes.
“If you think about it, they could have lost that very easily and never gotten it back,” Minhas, who has launched his own startup, a Silicon Valley engineering recruiting service called JetCake, said. “Or I could have lost the 400K and never got anything for it.”
Chou came up with the idea during the dot-com era
ESO Fund, which started in 2012, has funded more than 1,000 individuals from more than 400 companies, Chou said. He said he came up with the idea for the fund in the early 2000s after the dot-com boom when stock options became one of the principal ways to compensate employees.
Chou found out that many people were simply walking away from options because they didn’t have the funds to exercise them. That led him and other investors to set up the fund.
ESO Fund has helped clients exercise stock options worth as little as $1,500, and has funded much bigger deals worth a few million, Chou said. “A median transaction is probably $55,000,” he said.
Chou said ESO Fund is ideal for young people working for startups who do not have the resources to exercise stock options.
“Younger people have less money saved to do this,” he said. “And younger people are less likely to be connected to the alternative sources of capital, you know, like wealthy friends or, or something like that.”
Of course, ESO Fund will not offer funding to any startup employee. The biggest challenge for ESO Fund is figuring out which startups are worth the risk — and which ones may be bad news.
“What we’re doing is effectively investing,” he said. “Granted, these are small-scale numbers, but it all adds up. We have to do due diligence just like a regular VC. Since we don’t have access to all of that information, the formal presentations of the company and stuff like that, we sort of have to infer the health of the company through public sources.”
‘Cycles are part of doing business.’
They do the due diligence with the help of cutting-edge AI and Machine Learning technology. ESO Fund has a data team that is “constantly gathering lots and lots of information,” Chou said. He would not elaborate on their methods, but he said their data team considers all kinds of information, from the age of the startup’s CEO to “whether their street address ends in an even number.”
“When I run the machine learning it will identify attributes that do matter,” Chou said.
The system isn’t perfect. ESO Fund has worked with clients from startups that turned out to be in bad shape. One prominent example is WeWork, the once hot startup whose public offering got shelved amid serious questions about its financials and business projections.
“Yes we have some WeWork but the fund is highly diversified so no one company makes us or breaks us,” Chou said.
In fact, he sees the WeWork fiasco as a reminder of the cycles that VC investing typically goes through. “A WeWork-like disaster becomes the poster child for every VC-industry correction,” he said.
Chou has seen his share of corrections and downturns, including the tech dot-com bust in 2000 and the great recession a decade ago. “Cycles are just a part of doing business and will never end,” he said.
But in a time of growing economic uncertainty, the process of picking winners can certainly be trickier for ESO Fund. Chou said that in the event of a downturn “more companies will struggle to raise capital, investors are going to concentrate capital only on their best assets and the probability of companies dying will be higher.”
“So, that means we will probably say ‘No’ more often,” he said.
But Chou said he remains upbeat about the future.
“I’ve been in this business for a long time and the doors have been slammed many times and it always comes back because of the fundamentals of the country and the economy are still there,” he said. “Just because the market’s not super warm and receptive, it doesn’t mean it doesn’t exist. So I’m not concerned. We’ll still deploy capital. The venture community will still deploy capital. I’m positive of all these things.”
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