INSIGHT: When Unicorn Employees Revolt and Push for IPO

On Sept. 24, Adam Neumann, the CEO of WeWork (now known as We Company), stepped down in the face of widespread skepticism of WeWork’s business model, overall value of the company, reports on self-dealing, and other corporate governance failures.

Neumann’s resignation comes as no surprise in light of the abrupt cancellation of We’s much-ballyhooed IPO. In the wake of the WeWork debacle, some may wonder why other private equity darlings like Airbnb are still committed to putting themselves through the indignity of an IPO at all.

With a seemingly endless supply of private money available at rich valuations to fund promising tech startups, who needs public markets? But the purpose of the IPO is changing. It’s not just about raising money anymore. The pressure to go public may not be coming exclusively—or even primarily—from a start-up’s owners, but rather from its employees.

Employees Push for IPO

The New York Times reported that Airbnb employees are pushing the company to go public because the employees want to be able to finally benefit from their options when the company goes public. After the company’s stock is traded on a public exchange, the employees can sell the stock they acquired upon exercising their options and thereby realize the upside value that they helped create.

So Airbnb announced that it plans to go public in 2020. Airbnb is considered a unicorn, a privately held VC-backed startup firm that is valued at $1 billion or more. In lieu of WeWork’s failed IPO attempt, Airbnb is perhaps brave to follow the footsteps of other tech unicorns that recently went public, such as Uber, Lyft, Slack and Pinterest.

Why are golden handcuffs not effective anymore? Airbnb and other unicorns are staying private longer than 11 years. Traditional stock option contracts were designed based on the principle that it will take the startup about four years or so to go public. This delay in IPO causes “lock-in” and illiquidity for unicorn shares. A unicorn employee is faced with a dilemma: when her early employee options are expiring (according to the tax code after 10 years) or she desires to leave the firm, she must choose between forfeiting her options (and her chances to getting rich) or exercising her options and paying taxes on profit that may never materialize.

Historically, individuals chose to work at high-risk startups for a modest cash salary with significant stock option grants, dreaming of cashing out for a large sum of money after an IPO of the startup’s stock.

Employee option grants made it possible for employees to participate in the growth of the business without having to put significant amounts of capital at risk or paying income tax that would ordinarily be due on additional cash compensation that companies offered to win the war for talent. This mechanism became popular due to the recognition that employee equity-sharing improves overall firm productivity, shareholder returns, and profit levels.

War for Talent

By contrast, today, unicorn pre-IPO valuations are very high, and employee options are now prohibitively expensive to exercise for some employees. If Airbnb remains private, for example, the employees may not be able to afford to repay any loans taken to pay the exercise price and associated taxes if they exercised their options. As a result, the value of the employees’ options will be diminished, which helps to explain why unicorn firms have a high turnover rate and experience difficulties with attracting, engaging and retaining talent.

Unicorns are accordingly under pressure to seek for other compensation mechanisms and contractual arrangements. The shift in employee expectations is evident from the frequent reissue or revision of equity grants and unicorn management’s experimentation with alternative organizational strategies to try to provide liquidity opportunities to employees and early investors. For example, the New York Times piece reported that “over the years, Airbnb has extended rules around exercising stock options to make the ‘golden handcuffs’ less onerous.”

Many companies, including Airbnb, try to innovate and experiment with alternative organizational strategies to facilitate liquidation opportunities to their employees. These new liquidity practices can take the forms of:

• a private IPO (akin to Spotify’s direct listing); or
• issuance of restricted stock units (RSUs), after the unicorn reaches the $1-billion valuation threshold; or
• a secondary sale to a single buyer (or an existing shareholder), so that the sale doesn’t violate section 12(g) of the Securities Act.

For example, Uber facilitated a secondary sale for its employees before it went public, via a SoftBank tender offer. It should be noted that despite the rise in electronic secondary platforms that are designed to match between employees and potential investors, such as SharesPost, many companies put restrictions on their employees’ ability to trade on these platforms. Unicorns are concerned with exposure to the risk of lawsuits by buyers (for omissions and misstatements under the securities law).

Secondary Markets

Some employees try to circumvent these restrictions and enter into shadow forward contracts in order to trade their stock. This practice can create problems to the buyers and the unicorn firms because of the fluctuation in valuation. The problem with the rise of secondary markets is asymmetric information. Many unicorns do to not provide employees with enhanced disclosure. This must change.

In order to make secondary markets more efficient, unicorn firms must change their practices and provide employees with enhanced information, especially concerning the risks associated with investing in illiquid securities of a high-risk venture that is often controlled by founders who lack management experience (see Uber ex-CEO and WeWork current-CEO examples), as well as disclosures on current and future stock issuance, list of investors (including liquidation preferences), and the estimated fair market value of their stock.

Most employees would be unable to bargain away from the predominant practice of tying them to the firm with equity and a promise of equity, because to do so might send a hostile signal to the market and to their employer, which they would like to avoid. Therefore, unicorn employees revolt and push the company to an IPO.

Realizing that although they are only “rich on paper,” employees cannot liquidate and reap the benefits of their hard work without an IPO.

The problem of inefficient retention function of unicorn stock option plans was recently discussed in a study titled “Unicorn Stock Option.” The current securities and tax laws must change because they create legal barriers to private ordering that prevent the relevant parties from solving these issues on their own.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Anat Alon-Beck is an assistant professor at Case Western Reserve University School of Law. She is the author of a paper titled “Unicorn Stock Options – Golden Goose or Trojan Horse?”