What Should You Do With Your Options During a Downturn?

NOTE: This information is not financial or tax advice; it's just general educational content and could be good to know. Even though he is employed by Compound Financial Inc., everything Adam Keesling writes in this article is not the official view of his employer. Please do your own research and make your own decisions, which is best done with the help of a professional advisor, and don't ever, for any reason, do anything to anyone for any reason ever, no matter what, no matter where, or who, or who you are with, or where you have been, for any reason whatsoever unless it is permitted. 

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If you were granted $100,000 worth of shares in Doordash ($DASH) on November 15, 2021, your shares as of June 1, 2022 are now worth $28,839.82 (-71.2%).

If you were granted $100,000 worth of shares in Robinhood ($HOOD) on November 15, 2021, your shares as of June 1, 2022 are now worth $26,802.06 (-73.2%).

If you were granted $100,000 worth of shares in Coinbase ($COIN) on November 15, 2021, your shares as of June 1, 2022 are now worth $19,872.02 (-80.1%). 

If you were granted $100,000 worth of shares in a private technology company last year, well – what do you think your shares are worth now? 

Unless your company is performing exceptionally well, chances are things could get rocky. 

You, technology startup employee, are now faced with a choice. You can either exercise your options, stay at your current company, and build yourself out of this situation. Or, you can invest your money elsewhere, reconsider your current job and explore the market on your own. 

In this article, we’re going to start by walking through a framework: should you exercise your options or not? Then we are going to use an example of a unicorn company (a startup valued at >$1.0B) to outline three scenarios of what startup employees can do with their options. We’ll walk through their situation and the actions they can take in the current market environment. 

Exercise or not? 

Is it even worth figuring out?

Before I get into a framework of how to decide, I want to take a step back and talk about time. Time? Yes time. 

Time is your most scarce resource and you can spend your time in any way you want – you can spend it with friends, you can volunteer, you can spend it working out. You can also spend it reading business articles on the internet :). 

Most people have to spend a lot of their time at a job to earn a living. Because of this, it’s worth making sure you’re at a job you’re excited about, utilizes your skillset, and fairly compensates you. So what about startups?

Now, if you want me to be completely honest, I don’t actually think working for a startup is good choice if you are optimizing your financial outcome. Not that startups pay poorly (let’s be real – they are pretty cushy compared to most jobs in the world) but in comparison to big tech, for example, there’s a lower financial “floor” and the “ceiling” is really, really unlikely. 

But even with this view, I chose to get a job working at a startup. 

So, Adam, why do you work at a job that you think isn’t a good financial decision? 

I’m lucky to be able to work at a startup for reasons other than purely financial ones. I work at a startup because of the autonomy (I can’t stand bureaucracy), the exceptional people I work with and learn from, and the small chance of having a life-changing financial outcome. (Plus we are building some pretty sick products for tech employees). 

I’ve heard similar stories from other people who work at startups. The choice to join a startup is usually for one or more of the following reasons:

• Mission or impact of the company
• People you are working with
• Chance at a large financial outcome
• Learning opportunities
• And many other reasons

Now, some people get the job choice right but screw up on the financial side. This is even more common at startups than in other kinds of companies because illiquid equity is such a large part of the compensation package and is often misunderstood. And it’s a shame because even though these people like their job, they aren’t rewarded in the way they thought they might be. 

In many cases, people implicitly choose not to figure this stuff out. And listen – I don’t blame them. ISOs, NSOs, AMT, QSBS… it’s daunting. And much less fun than building products. Ultimately, it’s your choice if you want to put in the effort to learn about your equity. 

But I’m here to reassure you that tax lawyers don’t actually rule the world (thank god). And if you do put in the effort to figure it out, it could be the most valuable investment you make. Often choosing to exercise your options sooner rather than later can save you hundreds of thousands or millions of dollars in taxes that you would’ve had to pay if you exercised them later.

So if you’re interested in being informed about your equity – what should you do?

Do I have liquidity? 

When you join a startup, you are usually given equity options as part of your compensation package. Options are the right to purchase shares at a certain price (called the strike price) and exercising your options is when you use cash to purchase your options, turning them into shares. 

So the first thing you need to figure out is if you even have the money to take action. If you don’t have any liquidity (assets like cash or public investments that can be easily turned into cash), then the choice is pretty easy: you shouldn’t exercise your options because you can’t. 

It’s common for startup employees early in their career to have no liquidity and thus not have the ability to exercise their options. They just haven’t had the chance to save money yet. 

One way to determine whether you have enough liquidity (besides simply looking at your checking account) is to save an emergency fund and then see if you have any remaining money after that. Typical emergency funds are 3-6 months of living expenses. So run the math, see if you have excess funds, and if you do, you can consider using them to exercise your options. 

This is just one framework though – if you want to spend every last dime on exercising your options I can’t stop you. I will say that my compliance officer Ben requires me to say this is just educational and not investment advice so do your own research or whatever. 

So now that you have a good sense of options, let’s dive into an example and discuss what to do specifically in a downturn. 

Company example: Unicorn chops its horn

First – what’s a markdown? 

A “markdown” is when a startup raises at a lower valuation than its last round. Markdowns occur for one or more of the following reasons:

• The company needs to raise capital and can’t find investment at a higher valuation
• The company has failed to hit milestones or meet investor expectations
• The market values the future cash flows of a company lower than before

Markdowns are most common in slowing market environments – if customers are purchasing less and the capital markets are tighter, it’s more likely that a startup will have to markdown their equity. It’s just worth less than before. 

The scenario we are going to examine is a unicorn company that experiences a markdown. The example will be simplified but relatable. It’s simplified in that we are ignoring any unique equity terms. It’s relatable in that even if the company you are at is a few stages earlier or a few stages later, you’ll be able to connect the company’s characteristics to your situation. 

Unicorn - founding days 

Unicorn was founded in 2017 and shortly thereafter raised a seed round. Because of their repeat founder and early traction, they raised a $5M round. This money funded the company as they built the right team and signed their early customers. 

A year later, Unicorn decided to raise a Series A to accelerate their trajectory and give them a stronger chance of beating their competitors (the market was starting to notice that they were onto something). They raised a $15m Series A at a $75M valuation. 

Unicorn becomes a Unicorn

The unicorn company continued to succeed—they raised a $40M Series B the following year. Around this time they started hiring executives to manage the slew of engineers, designers, and product managers that were now on the payroll. In addition to building larger product teams, the funds also went to sales and marketing. 

In each subsequent year, they raised a new round: a Series C in 2020 and a Series D in 2021. They rode the bull market just like dot com darlings did in the late 1990s – their investors had plenty of capital and continued to urge them to raise more money. Their Series D even made Unicorn a unicorn, reaching a $1.2 billion valuation. 

Down round

In late 2021, the capital markets came crashing down—and while the company’s revenue was growing, they were burning a ton of cash in order to achieve it. So, instead of instituting layoffs, the company decided to raise a down round and push through it. The company was now valued at $900M —a 25% discount from their last round. 

Here are the valuation and share details: