What’s the Smart Thing to do with my Unicorn Options?

Managing risk and finding liquidity (while minimizing taxes)

Collective Liquidity · 17th Mar 2022

The problem with unicorn concentration and illiquidity

When you have shares or options in a private growth company worth a billion dollars or more, a “unicorn,” you’re one of the lucky few with a wealth creation opportunity that can potentially change your life. At the same time, everyone knows unicorns can decline in value even faster than they grew into their billion-dollar valuations. This is a particularly scary problem if your options or shares represent the bulk of your net worth. This kind of risk has a name: concentration risk (i.e., all/most of your eggs in one basket). Many employees and investors have unfortunately seen their paper wealth evaporate overnight as the price of their shares plummets due to a company specific problem or market crash. It’s not obvious to most people though what they can be doing to manage this risk.

The other challenge many unicorn holders have is an inability to turn private company stock into cash. The cash might be needed to make other investments, to start a new business or for something like the purchase of a new home. The good news is that the private market has come a long way over the last few years. There are now marketplaces that will broker your shares for you or your company might offer to buy your shares in a tender offer.

The bad news, however, is that, depending on your circumstances, stock sales can be taxed at very high rates and marketplaces can charge very high fees – as a result, you might keep less than 50% of the sale proceeds after paying taxes and brokerage fees. Stock sales can also take months of your time working with a broker to find a buyer and negotiate price and transaction agreements. Tender offers, on the other hand, don’t typically charge fees and terms are standardized, but they typically only happen once a year. If you miss it, you’ll be waiting while illiquid and at risk until the next one (and there’s no guarantee there will be a next one).

What to do about concentration risk and illiquidity?

Fortunately, there are two things you can do today to manage your risk and get liquid. First, understand that perhaps the best way to address concentration risk is through diversification. Diversification refers to taking a single asset, like your unicorn stock, and trading it for a basket of many stocks or other assets. If any one company (or asset) in the basket melts down in value, it’s manageable, because that one company represents only a small percentage of the basket’s value. The wrinkle here, of course, is how to diversify out of your unicorn shares given that they’re illiquid – we’ll come back to that problem shortly.

Second, to get liquid, consider alternatives to a stock sale. There are several such alternatives for the stock of a public company (i.e., companies that have had an IPO and are listed on national exchanges like Nasdaq or the NYSE). Unfortunately, for a variety of reasons, these solutions aren’t generally available for private company shares. Increasingly, an exception to this though are loans secured by your stock. These are a little bit like home mortgages: you borrow money and the lender uses your shares for collateral. The problem with these loans though is that they typically will only lend you a small fraction of the value of your shares and interest rates and stock and other fees can be astronomically high.

The Collective Liquidity solution

At Collective Liquidity, we can help you solve for both concentration risk and illiquidity quickly and easily. How do we do that? First, to address over concentration, we created the Collective Exchange Fund, a diversified basket of leading unicorns. If you hold shares in any of the companies in our target portfolio, you can exchange them tax free for a partnership interest in the fund of equal value. This allows you to trade the risk of a single unicorn stock for the lower risk of a basket of unicorn stocks. The tax-free nature of the exchange is a huge advantage because it gives you a dollar’s worth of diversification for every dollar’s worth of shares you exchange. By comparison, selling your shares for cash and diversifying by buying other assets might net you less than fifty cents worth of diversification for a dollar’s worth of your shares.

To get you liquid today, Collective provides access to Exchange Loans. Exchange loans are secured by your partnership interest in the Exchange Fund. You can borrow up to 60% of the value of your partnership interest with just a simple online application. The loans are tax-free so you keep all of the proceeds. They are also non-recourse to you which means that, no matter what happens to the value of your interest in the Exchange Fund, you always get to keep the loan proceeds. You never have to come out of pocket to repay the loan. When the time is right for you, you just redeem your partnership interest for cash and use the proceeds to pay off the loan, keeping whatever is leftover – which, depending on how the fund does and how long you wait, can be a lot.

Let's look at a quick example. Let’s say you hold $100,000 worth of shares in one of the unicorn companies in the Collective Exchange Fund. First you contribute the shares into the fund in exchange for a $100,000 limited partnership interest in the fund. Then, whenever you need liquidity, you borrow 60% of the value of your LP interest, in this example, $60,000, using your LP interest as collateral. No taxes are triggered by either your exchange into the fund or the loan.

Compare that $60,000 in after-tax proceeds from an Exchange Loan to the after-tax cash you’d expect from a stock sale. Depending on how long you held your shares and your state’s tax rate, you could pay up to 46% of the sale proceeds in taxes. Plus, you will probably be charged another 5% in brokerage fees. So, you might end up with just ~$49,000 in after-tax cash from a stock sale. And, again, note that with an Exchange Loan, in addition to the initial loan proceeds, you continue to own your partnership interest as it appreciates in value over time.

Estimate your available cash

If you’d like to learn more and see how much cash an Exchange Loan might generate for you, visit collectiveliquidity.com. Input a handful of data points about your shares or options and immediately see an estimate of your loan amount. The Estimator also compares your loan amount to the after-tax proceeds you might expect from a stock sale.

Important Disclaimer:
The information relating to the Collective Liquidity Exchange Fund (the “Fund”) has been prepared solely for informational purposes, is not complete, and does not contain certain material information about the Fund, and is subject to change without notice. It does not constitute an offer to buy or sell an interest in the fund or the provision of investment management or advisory services, nor shall there be any sale of a security in any jurisdiction where such solicitation or sale would be unlawful. The Fund’s limited partnership interests will not be registered with the U.S. Securities and Exchange Commission or other regulatory authority. Investors will be required to verify their status as an accredited investor to participate in any offering of the Fund's limited partnership interests. No securities commission or regulatory authority has recommended or approved any investment in or the accuracy or completeness of the information or materials provided by or through Collective Liquidity Asset Management, LLC or any of its affiliates (collectively, “Collective Liquidity”).

All loans issued by WebBank, Member FDIC. Interests in the Fund are not FDIC insured, are subject to investment risks and may lose their value. Interests in the Fund are not deposits and are not guaranteed by Collective Liquidity.
Prospective investors should consider the investment objectives, risks, fees and expenses of the Fund carefully before investing in the Fund. This and other important information is contained in the Fund’s Confidential Private Placement Memorandum (“PPM”), which can be obtained by contacting Collective Liquidity.
Investment in the Fund involves substantial risk and any offering may only be made pursuant to the relevant PPM and the relevant subscription application, all of which must be read in their entirety. No offer to purchase securities will be made or accepted prior to receipt by the offeree of these documents and the completion of all appropriate documentation. The Fund intends to primarily invest in securities of private, late-stage, venture-backed growth companies. There are significant potential risks relating to investing in such securities. The Fund is not suitable for investors who cannot bear the risk of loss of all or part of their investment. The Fund is appropriate only for investors who can tolerate a high degree of risk and do not require a liquid investment. The Fund has no history of public trading and investors should not expect to sell limited partnership interests in the Fund. No secondary market exists for the Fund’s limited partnership interests, and none is expected to develop. The Fund has a limited operating history, and its performance is highly dependent upon the expertise and abilities of its manager. There is no assurance that the Fund's investment objectives will be achieved, and results may vary substantially over time. This is not a complete enumeration of the Fund’s risks. Please read the Fund’s PPM for other risk factors related to the Fund. Although the manager of the Fund will value its portfolio using the Private Market Valuation Algorithm, it can be difficult to obtain financial and other information with respect to private companies, and even where the manager is able to obtain such information, there can be no assurance that it is complete or accurate. Because such valuations are inherently uncertain and may be based on estimates, the manager’s determinations of fair market value may differ materially from the values that would be assessed if a readily available market for these securities existed.
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