In a recent paper titled “Unicorn Stock Options – Golden Goose or Trojan Horse?” Anat Alon-Beck analyzes the issues arising in connection with stock-based compensation awarded to employees of unicorns given the trend toward remaining privately held longer and the deferral of IPOs, which traditionally served as the principal liquidity opportunities for employees.
The paper notes that for many Unicorn employees, choosing between exercising their options or forfeiting them is difficult. Valuations for unicorns may be high, so paying the cash exercise price and meeting the tax obligations may be difficult for an employee. Even if the employee were to exercise, the underlying stock would still be illiquid. Moreover, for many employees that choose to leave their companies, the standard option terms provide for a limited period of 90 days or so during which departing employees must make a decision whether to exercise. Given information asymmetries, employees may not have a well-formed view regarding the value of the stock. Many of these factors appear, according to the author, to be contributing to the high turnover among unicorns.
The author notes that stock-based compensation models were premised on the fact that most entrepreneurial companies had a lifetime of four years or so to IPO. With an extended timeline to IPO, the author suggests that it may be necessary to formulate a new approach to compensation. Possible alternatives may include: longer vesting periods, longer periods in which to exercise when an employee departs, back-end loaded options and greater reliance on RSUs. However, each such alternative has its limitations. As a result, the author contends that regulatory reform is needed. First, the author calls for changes to the Exchange Act Section 12(g) threshold to include employees in the holder count and more rigorous information requirements for companies under Rule 701. Given that the SEC’s Concept Release relating to Rule 701 and Form S-8 generally reflects a predisposition for less disclosure and greater flexibility, the article provides an interesting counterpoint. As the author notes, current regulations did not contemplate the growth of unicorns and, while increased flexibility for stock-based compensation grants may be useful, it does not address the information disparities or the lack of liquidity for employees and other optionholders.