For tech startups facing economic uncertainty, reducing salaries and offering stock are more attractive alternatives to losing staff, but the trade-off could hurt employees if the startups fail to make it to the initial public offering.
Every employee dreams of becoming a millionaire through stock options like the ones that made thousands of people rich at Facebook, Google and Pinterest, to name a few. The spectacular success of Silicon Valley startups and the resulting wealth of employees who held stock options made stock option plans a powerful motivational tool for employees to work for the company’s long-term success.
Almost everyone hired at WeWork received stock options as part of their compensation, and employees waited years to sell their equity in the company.
Things were looking good for about 1,500 eligible current and former WeWork employees. By January 2019, venture capitalists had pushed the valuation to $47 billion. The commercial real estate company was planning to go public based on its business model of providing shared workspaces for tech startups.
Then WeWork’s hoped-for initial public offering collapsed in the fall of 2019, and SoftBank, its largest investor, reneged this month on a $3 billion buyout of existing shareholders.
WeWork employees told Forbes they were counting on SoftBank’s share purchase to send kids to college, provide emergency funds in a failing economy, and pay off a mortgage or medical bills.
SoftBank employees stood to gain $283 million to $580 million.
Now the economy is tanking as a result of the coronavirus and uncertainty. A growing number of startups are offering stock-for-salary trades to preserve cash, Bloomberg reported.
Venture capitalists have warned startups that funding could dry up in Silicon Valley, prompting many startups to try and preserve cash to last a year to 18 months. In the first quarter of 2020, the number of VC deals shrank by 27 percent while total money invested stayed mostly flat. More than 24,000 employees have been let go at hundreds of tech companies, according to tracker Layoffs.fyi.
Startups have cut salaries from 10-to-40 percent in recent weeks, according to Seth Bannon, who runs the venture capital fund 50 Years. For startups trying to cut costs, boosting equity for employees is “a way for companies to say, we’re cutting salaries but you didn’t do anything to deserve this, so we’re giving you an equity bonus that makes up for it,” he told Bloomberg.
Business is booming for Medal.tv, a gaming startup that’s benefiting from house-bound customers sheltering in place. However, half its employees are taking salary cuts during the pandemic.
In return, they’re getting restricted stock units which will vest over a year. Employees should be able to sell those shares when Medal closes its next round of financing, whenever that will be.
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“If everything goes well, not only does the company save money and slow down its cash burn, but the employees that exchange their salary for stock will have a bigger payout during our Series B round,” said co-founder Pim de Witte.
Medal says the pay cut and stock option swap were voluntary. It’s a move that only works for “employees who believe in the financial outlook of your company,” De Witte said.
Some VCs caution against being too quick to give away shares.
Edith Yeung, a managing partner at early-stage fund Proof of Capital and adviser to 500 Startups, advises startups to first try to slow the cash burn by reducing rent and software costs or delaying payments and other expenses.
Trading shares for salaries “would be the last advice I give to companies trying to survive this pandemic,” she said.
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