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What Do Falling Valuations Mean for Tech Employees' Equity?
Here are steps you can take to maintain the trust of your employees with equity when there is a drop in your company's valuation.
September 7, 2023
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Tech valuations have endured stark declines this year. After reaching eye-watering levels in 2021 and 2022, valuations have dropped dramatically for many firms.
Molten Ventures recently devalued its holdings in Revolut by 40%, the firm's third write-down in four months. Earlier this year, Allianz moved to sell its 5% stake in N26 at a 68% discount. Stripe cut its valuation to $50 billion (£39bn) in March this year, which is well below its peak of $95 billion back in 2021.
With venture capital firms such as Tiger Global writing down venture investments by a third and struggling to raise capital for new funds, the tech industry is in for a difficult year ahead.
We all know this is bad news for the tech sector generally, but what does it mean for employees with equity?
Underwater Equity
Firstly, a drop in valuation is not permanent. Good firms' values will rise again, so the outlook isn't necessarily all bad and there's no need to panic.
Early employees who joined the firm at a lower valuation will likely still be "in the money" as long as the new valuation is still higher than when they joined.
Employees who joined and were awarded equity at a time of high valuation could see their equity go "underwater" as valuations drop. This means that the price they'll pay to exercise their share options is higher than the value of their equity stakes. If you exercised your shares in this context, you might lose money.
While being underwater isn't ideal, it's not necessarily cause for alarm. Any "loss" isn't crystallized unless those employees sell their shares, which would not normally happen without a liquidity event like a public listing, merger, or acquisition.
What might make a difference to someone's financial outcome is the length of time employees get to exercise their options and when they leave the company. More and more, companies are adopting progressive policies that allow employees five or even 10 years to decide whether to exercise their options.
If your equity is "underwater," being able to wait and see what happens to the business over a number of years releases some pressure and gives you more awareness of the risks and opportunities of becoming a shareholder.
But many companies still operate restrictive policies that give employees as few as 30 days to decide whether they want to exercise their options. This often leaves people weighing whether to pay out thousands of dollars to acquire shares in an early-stage company where the eventual return is highly uncertain — or to forfeit their right to their equity altogether.
How Can Employers Protect Their Employees?
As an employer, the first thing you should do is be transparent. If your valuation has been marked down, or you're raising capital at a lower valuation, tell your employees and describe the potential effect on their equity.
This is particularly important for companies that offer restricted stock units (RSUs), where staff are unable to vest unless the firm IPOs. If it looks like the shares are nearing their expiration date and the company isn't in a position to float, it's essential to engage in a conversation on what this will mean for employees and what the next steps will be for the firm.
This will be very different for different people so, if possible, describing what it means for each individual in a one-on-one context is the best practice. If this isn't possible, consider sending out a tailored note via your equity management software.
Next, there are ways to mitigate the impact on employees' equity stakes. Companies can try to correct for any decrease in value by issuing each employee additional share options at a lower strike price, or by repricing options.
In the latter case, the company effectively cancels existing options and reissues new ones at a lower strike price. This method is most likely to be used by late-stage pre-IPO companies such as Checkout.com, which at the end of 2022 lowered the price at which staff can exercise their stock options from $252 to around $65. Notably, Checkout didn't wait for its valuation to drop to reprice equity — instead, the leadership team took proactive steps outside a fundraising environment.
Stripe went a step further in March, announcing that investors would buy $6.5 billion worth of employee shares. The move lowered the payment company's valuation to about $50 billion from a high of $95 billion. John Collison, co-founder and president of Stripe, said: "Over the last 12 years, current and former Stripes have helped build foundational economic infrastructure for millions of businesses around the world, and this transaction gives them the opportunity to access the value they've helped create."
According to Bessemer Venture Partners, many late-stage companies are looking at similar transactions to let employees sell around 20% of their vested stock. But not every firm is as attractive to investors as Stripe, and so this route is only realistic for a handful of tech firms.
These approaches will probably involve negotiations with the board and investors. They can also create significant additional workload for the finance, people, operations, and legal teams, depending on which function has responsibility for equity plan management.
These steps aren't easy, but taking these actions demonstrates to your employees that you take their equity seriously. Negotiating a valuation drop with transparency and effective mitigation can help maintain your team's trust and motivation through difficult times.
Yoko Spirig is co-founder and CEO of Ledgy.
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