To the honour of this blog’s name, my inspiration for this week comes from a Financial Times article, discussing the tax implications of expiring staff share awards in start-ups, as IPOs take longer than expected to materialize.
Today I would however prefer to focus on the economic implications of the recent sharp decline in tech start-ups valuations over the last few months, mimicking the trend observed for more mature tech companies – Meta/Facebook’s share price is down 54% from its September 2021 peak, Spotify is down 65% and Snapchat… 87%. The drop has obvious implications for the shareholders but also for the employees, who have often accepted a lower cash compensation in exchange for shares or, more often, options that materialize into shares in ‘liquidity events’, such as an IPO, an acquisition or a new funding round allowing this kind of cash conversion.
Let us put ourselves in the shoes of Mark, a fictitious individual who decided to join a start-up (specialized in metaverse, to make the example even more telling) in the heat of the tech bubble, i.e. in late 2021. Mark accepted at the time to take a cut on his salary because he was granted 0.05% of the company’s capital, which was at the time valued at USD50m according to its latest funding round, with an ambition to go public in the next 3 years at a valuation of at least USD1bn – so Mark’s share prize would be worth USD500k.
Unfortunately the climate has since then changed, growth has slowed and the prospect of an IPO seems more remote than it was a couple of years back. So Mark is now in a situation where either the liquidity event never materializes (in this case his shares are worth 0) or the company goes public or gets sold for the same valuation as the last round, i.e. USD50m. In this case Mark does not make USD500k but USD25k… Mark’s total package is much less attractive than it used to be. If the company wants to retain Mark, it should either increase his cash compensation (therefore harming the company’s cash situation) and/or increase his stake in the company (therefore diluting existing shareholders). If it does nothing, it is at risk of losing Mark, who is now relatively underpaid compared to his market value.
Mark’s fictitious situation is unfortunately rather representative of the one currently faced by many employed by those start-ups. The financial argument is obviously not the only reason why these people decided to join these entrepreneurial adventures. But it undoubtedly plays an important role. In a world where the tension over talent is, for the moment, still high, and in a sector where intellectual capital plays an important role, this is a real risk that these start-ups will have to deal with.