Investing in alternative assets and why you should care about them?

by Sandeep Kumar | June 1, 2021

What is the meaning of a secondary market?

The private secondary market is the one in which stakeholders of private, venture-backed companies (employees, ex-employees and early investors) wish to transfer their shares to an investor in exchange for liquidity. The investor on the other side exchanges cash in return of shares of that private company. The sales proceeds go to the selling shareholder, not to the company.

A primary issue of shares is the source of equity for a given company. Primary issue happens when a company issues a new class of shares and grants those to employees (in the form of stock options) or sells them to investors in an event of fund raise. The employees and investors who own primary shares may choose to sell them in the secondary market, through Torre Capital’s marketplace.

How can you diversify your portfolio and expect higher returns by investing in the secondaries market?

  • Given the expense of going public (which can be significant in terms of time and resources) and the public markets’ short-termism (which can cause public companies to focus on quarterly earnings and not on long term growth).
  • Tech-Based companies have fewer reasons to go public than they did a decade ago, because of which the venture-backed technology companies are increasingly reaching $1B and even $10B valuations before they go public, which leaves less potential for public market investors. In the year 1999, US technology companies went public typically after 4 years but today, the average technology company IPO comes after a minimum of 10 years.
  • As the companies are taking longer to go public, their early investors and employees have to wait substantially longer for liquidity than they would have in the past.

There are many reasons why early shareholders of now valuable private companies might want to tap into liquidity through Torre Capital. For example, an early stage venture capital investor might want to return capital to limited partners ahead of the launching of a new fund. An early employee of a now late-stage company might want to sell shares to finance transactions like buying a house.

Torre Capital acts as an intermediary between the shareholders who need liquidity, and the investors who want investment exposure to proven technology companies before they ultimately go public or get acquired. If the company goes public, investors receive shares post the lock-in period (which restricts private company shareholders from selling their publicly traded shares, ranging between 6 months to a year). If the company is bought for cash, the investors are compensated for the same as well.

More than $50 Billion in value is estimated to be locked up in private, pre-IPO companies, and the secondary market is unlocking that value for investors who were previously unable to participate due to high minimums and restricted entry.

Who influences the pricing of the secondary market?

The investors who participate in the fund raise have an influence on primary market prices; secondary transactions are usually priced in relation to the most recent funding. The price is generally influenced by factors of supply and demand. If a private company has a high demand, its shares might trade at a premium in the secondary markets (in other words, the shares would be priced higher than the share price from the most recent funding). If the sellers of a particular security are more than its buyers, the shares might trade at a discount (lower than the share price from the most recent funding).

Apart from the influences of demand and supply, following are the other factors that can affect the price per share of private market securities:

a. Share Class: Two of the primary types of shares are preferred stock and common stock.

  • Preferred stock is a type of equity security that has certain rights over common stockholders. These rights may include, but are not limited to, liquidation preferences dividends, anti-dilution clauses, and managerial voting power.
  • Common stock is a type of equity security that is most frequently issued to founders, management, and employees. In the event of liquidation, preferred shares are generally given priority over common shares.

b. Discount for Lack of Marketability: A valuation discount exists between stock that is liquid and traded publicly, and stock that is illiquid and not publicly traded. Because Torre Capital’s offerings are relatively illiquid, it’s common for them to be priced at a discount to the most recent round of funding.

Why invest with Torre?

Torre Capital is a VC funded Singapore based Financial Technology company and a Registered Fund Manager in Singapore. We are creating a fully digital Wealthtech to connect family offices and HNI investors with global opportunities, including alternative assets like Private Equity, Venture Capital, Real Estate Funds, and Hedge Funds. Our investment vehicles offer exposure to high quality global growth startups, private debt opportunities, and other thematic funds in the pre-IPO space. They are available to registered investors around the globe.

Our current customer set includes 500+ family offices and High net worth investors (CXOs, first and second-generation entrepreneurs). With the team composed of ex-Mckinsey consultants, Asset management veterans, and Digital experts.

Exclusive features offered by Torre:

  • Pre-vetted/ Curated funds
  • Low-minimums
  • Low and transparent cost
  • End-to-end digital

Who are the shareholders?

Shareholders include all angel investors, employees of the company, founders, or anyone who currently has equity in an eligible private company in the form of common shares, preference shares, stock options or restricted stock units. The following services are provided by Torre Capital to private company shareholders:

  • Opportunity to sell shares in the Torre Marketplace
  • Avail equity funding for your private company ESOPs

How does the Shareholder’s journey work?

a. For selling shareholders:

  • Register on the platform by providing a few basic details about your equity stake.
  • Explore the Torre Capital marketplace to submit your request. Our private market specialist connects with you to perform due diligence checks.
  • We offer the shares to our investor community and gather investment commitments. We also work with the company directly for a completely secure transaction.
  • Transfer documents executed and you receive the sale proceeds. Torre Capital charges a nominal transaction fee.

b. For shareholders who seek to avail equity funding:

  • Register your interest and submit your financing request. Find out how much funding you can avail.
  • Our credit experts get in touch with you to perform due diligence checks, understand your tax liability and underwrite the funding.
  • Depending on your company’s terms and agreement, the forward equity contract is signed and you receive your funds.
  • Share a portion of profits with us post liquidation event. In case of no liquidation event, you don’t have to pay us back.

Advantages of selling at Torre’s Marketplace:

  • Immediate Partial Liquidity.
  • Maximum benefit to shareholder: You only pay us in case of a liquidity event.
  • Get to keep your upside: If your company never meets a liquidation event, you still have received funding for part of your shareholding.
  • Minimized Risk: Upfront part funding and safety of investment till liquidation. 
  • Multiple asset class: If you own multiple classes of preferred stock, common stock, ESOPs, RSUs, you can sell them easily on the Torre Capital marketplace.

Who are the investors?

Currently only accredited investors as defined here are able to make investments through our platform (Investments are not open to US Citizens). With Torre’s platform, the opportunities are endless. You can choose to allocate capital across four different asset classes – equity, ESOPs, structured products, and funds.

How does the investor journey work?

  • Register your interest on our platform. We leverage our network to provide company specific offerings to all employees.
  • Reserve your interest. All IPAs issued post approval.
  • Shareholders agree to terms, sign a Forward share ownership contract.
  • Funds transferred to shareholders’ account. Company leadership informed of agreement with Torre Capital. Receive frequent updates.
  • Upon liquidation, receive principal and profits redemption requests raised to shareholders.

Advantages of investing at Torre’s Marketplace:

  • Exclusive access to high-growth startups: 20% – 30% discounted equity ownership in series D and above global pre-IPO unicorn/soonicorn shares leading to lower investments than secondaries.
  • No upfront cost: Zero transaction cost versus 10% charged by secondaries.
  • Attractive Returns: 3x – 5x better returns than direct secondary transactions.
  • Vigilant and protective measures: 3x collateral protection for initial investment till 80% downfall in stock value.
  • Faster cash-inflows: 3x – 4x faster return of capital than top VCs.

Torre’s Pre-IPO Fund

If you believe in the power of the Torre Capital platform for sourcing strong deal flow and you believe in the pre-IPO asset class, but you are not comfortable or otherwise do not want to select single names for investment, you should consider a managed fund investment. The Fund Series investment committee will select all investments, which are a curated subset of what comes across the Torre Capital platform.

If you would like your investment to give you diversified exposure to the pre-IPO asset class, but can’t commit to multiple $100,000 investments, a managed fund is a good option. You will get investment exposure to multiple pre-IPO companies that are carefully selected by the fund series investment committee.

Related Posts

Startup investing 101: The HNI’s guide to investments beyond the conventional asset class

by Sandeep Kumar

Why invest in startups?

Investing in a startup is a high-risk, high reward game

Deciding the right opportunity and best practices for investing in a startup

Ways to invest in startups

Delaying the IPO comes with certain advantages for Startups

How startup investing really works

When can you expect a return or are you locked in forever?

Source: Pitchbook and CBInsights

Exits are what investors care about, but many founders dream of becoming a unicorn and avoid using the word “exit” until it’s too late. Despite this, M&As accounted for 97% of departures in 2020. And the majority of them occurred prior to Series B.

Exit or no exit: A fatal call

In a low-yield world, is Pre-IPO investing the hidden secret to higher yields?

by Sandeep Kumar

  • Pre-IPO secondary transactions are growing, and over the past few years have consistently generated higher returns over other traditional asset classes
  • Startups are remaining private longer. The average age of technology companies going public has gone from 4 years in 1999 to 11+ years now. As a result, several broker networks and pre-IPO marketplaces have emerged to provide liquidity to early-stage investors and employees
  • Our analysis shows that secondary investments in mature startups 2–3 years prior to a liquidation event have yielded between 40%-70% annualized returns with fairly high success rates. That’s not a typo!
  • Case in point — Slack went public with IPO priced at $38.5 per share, earning around 200% above the last private funding round 10 months prior to the IPO
  • However, investing in Pre-IPO is no silver bullet. Just like all other forms of investing, you can go wrong and will go wrong. Imagine investing in Airbnb in 2017, or in Bytedance in Dec 2019. Airbnb’s valuation has halved since, while Bytedance has taken a nosedive.

It’s been busy year for public markets. The pandemic shock and resulting global economic turmoil has seen world exchanges experience a never before roller-coaster ride in the last few months. What with the V-shaped recovery in the stock markets and emergence of Robinhood traders across the world, equity is the name of the game right now. A slew of technology startups is slated to come up with IPOs in the next 12 months, and people are actively debating investing in these IPOs for listing gains.

There is a set of investors, however, who already own shares in most of these Pre-IPO companies, and are waiting for listing gains. They purchased these shares either directly from angel investors, early-stage VCs, and employees holding vested ESOPs or from one of the secondary marketplaces mostly available in the US.

To give you some perspective, our team went back 5 years and looked at the secondary market valuation histories of all IPOs that happened during this period.

(All numbers are taken from actual secondary transactions. Data for a few years in not available.)

Returns realized from investing in Pre-IPO companies 1/2/3/4 years prior to IPO event startups

If you don’t like dense tables, let us call out a few things:

  • If you had invested $ 10,000 in Beyond Meat on 02 Oct 2015, it would be worth $ 102,000 as on 02 May 2019, the date of listing.
  • If you participated in a secondary transaction as on 21 Sep 2018 in Lyft, you would make a cool 150% return in about 6 months. On the other hand, if you bought Lyft as a retail investor in the IPO, you would be sitting on an approx. 70% loss right now.
  • On a more modest note, an investment in DropBox or Uber in late 2015 would earn you only a 2–3% annualized return, highlighting that not all hits are a homerun.
  • Other notable names are Slack (42% annualized return), Roku (88% annualized return), and Coupa (104% annualized return)

Our outside-in neutral perspective can be summed up as:

  • If you make a good selection (right about 60–70% of the time) of investing in the right startups in the secondary markets, the returns far outweigh any other asset class with comparable risk.
  • The biggest benefit to the investor according to me is the shortened investment period. Shorter the time period, lesser chances of something going wrong. In the time that it takes to invest and wait in an early-stage VC, you could churn your money twice and maybe make higher, but more certain returns. Corollary being that shorter the investment time horizon, shorter can be the returns as well.
  • You get to invest in high-growth Unicorns at an earlier stage before the company goes public and leftover gains are distributed.
  • A mature startup is slightly more stable, has proven product-market fit, has hopefully learned how to scale, and has a proven team that works well together. All this adds up to slightly higher principal protection.
  • Don’t go for overhyped startups, irrespective of how mature a startup is, you have to make a call on if the valuation has some margin of safety built in.

What is a Pre-IPO marketplace and how does it work?

Pre-IPO marketplace is a private market where the private company shares exchange hands between private (almost always accredited) investors. Pre-IPO shares are generally held by founders, employees and early-stage angels/VCs. Sometimes the holding period becomes just too long to tolerate (ask any early investors of Palantir!). VCs need to show performance and return capital, angels and company employees need liquidity. Ergo, the need to sell shares in the secondary market to new investors. Please note one important distinction. In a secondary sale, the company does not receive any proceeds from the sale, it is shareholders exchanging monies and assets.

With private markets maturing and investors getting more sophisticated, this secondary market has expanded rapidly over the past 4–5 years. The development of broker networks and secondary marketplace have reduced some of the liquidity concerns of the investors and contributed to the rapid growth.

How real are the returns?

Historically, stock markets have given returns of ~10% annually. But investing in select Pre-IPO companies, such as high growth tech startups can provide substantially higher returns. With a larger number of companies choosing to stay private for a longer-term, many investors (majorly retail) miss out on the ultra-high growth stage of the company. This is the stage where the company’s valuations rise multifold and retail investors miss out on the substantial portion of the returns waiting for the IPO to happen. Also, IPO is not the only liquidation event, instead there are a lot more corporates and private equities acquiring mature startups.

Take the example of the Direct listing of Slack, a popular workplace collaboration tool that went public in 2019. The Company raised series A funding in 2009 and decided to take 10 years to go public. Slack’s stock was valued at $11.91 per share in the last VC funding round 2018. Within a year, Slack’s shares after IPO opened at $38.5 per share, implying an approximately $23 Bn fully-diluted valuation Company’s price closed at 225% above the last private funding round 10 months ago.

Few other success stories in the last few years:

Zoom is a global video communication platform that went live with an IPO in April 2019. Zoom went live at a valuation of $10 Billion with shares priced at $36, by the day close shares traded at $62. Zoom in the last VC round raised $115million putting the company’s pre-money valuation at $885.03 million (at $14.97 per share).

Beyond Meat is a plant-based meat producer that went public in May 2019. The company’s IPO was priced at $25 per share, valuing the company to $1.5billion. By the end of the day shares were trading at $65 per share. The company last raised $50 million in 2018 at a valuation of $1.3 billion, with shares priced at $16.15 per share.

ForeScout is a network security monitory firm that went public in 2017, 17 years after it started its operations in 2000. Till date company has raised around $300 Mn in funding. In the last funding round company was valued at $1 Bn, but when the company went public the valuation of the company dropped to ~$800 Mn. This is an example of a situation where things didn’t go as planned.

Allocating a small portion of your portfolio to Pre-IPO high-growth securities can provide opportunities of earning substantially higher returns than investing in public markets, with risks lower than that of the initial stage VC investors. But it is no silver bullet where all the bets are winners, you have to be selective and meticulous in the due diligence of private companies before investing to earn substantial returns in Pre-IPO secondary market. Buyers beware!

Where will the Secondary pre-IPO Market go from here?

Private markets have grown and matured over the past two decades. Since 2002, Global Private Equity asset value has grown more than twice the rate of public market capitalization. At the same time, the private equity secondary market has also seen tremendous growth in volume. We believe that a similar progression of events may happen in the startup secondary market as well. Once very insignificant, the pre-IPO secondary market has evolved to become a very useful mechanism for founders, ESOP owners, CXOs to liquidate their private securities, either partially or fully. Companies now tend to remain private for longer period of time and thus increasing the relevance of the secondary market. Secondary pre-IPO market has seen a continuous growth in transaction volume and has become a reliable source to get differential exposure and skip the J curve. The chart below indicates the rising secondaries transaction volume.

What’s driving the growth of the Secondary pre-IPO market?

1. Longer gestation period to a liquidity event

To date, there are 400 unicorn startups (private companies that are valued above $1 Bn) globally. With large corporates and funds willing to back these companies, they don’t have a huge incentive to go public to raise funds. Going public also exponentially increases the compliance and reporting needs. According to McKinsey & Company, the average age of U.S. technology companies that went public in 1999 was four years. By 2014, that average rose to 11 years and the trend is on the rise. There could be many reasons factoring in a company’s decision to delay raising capital from public:

  • Additional cost involved
  • Incurring new and ongoing operational requirements (filing financial statements)
  • Losing autonomy
  • Risk of takeovers
  • The dreaded IPO flops
  • The delayed IPO exits have led investors to look for other options to exit and diminish liquidity concerns.

2. Founders need liquidity, VCs need to show successful exits

I was speaking to a founder who has been running a very successful tech startup in the valley for the past 10 years and may take another 4–5 years to successfully do an IPO or sell out. The problem is, he needs liquidity today to fund his kids’ education, mortgage, and other obligations.

VCs with a fund life of 10–11 years at times are unable to liquidate all their investments within this period. Given the need to return capital to investors, it can also become imperative to sell a portion of the portfolio in the secondary market. Whatever be the reason, the fact remains that there is increasing high-quality supply available in the secondary market.

3. Increased secondary market efficacy

With the advent of multiple offline brokers and online platforms (such as Torre Capital), it has become easy for founders to connect with buyers looking to acquire stake in unicorn startups. Increasing tokenization of asset classes using technology has also helped reduce investment minimums, documentation, and timelines.

How does the Pre-IPO market actually work?

Investing in Pre IPO shares generally can be done in a few ways.

  • One way to invest in unicorn startups is via Brokers or advisory firms that specialize in Pre-IPO secondary transactions. Using offline brokers or investment banks requires a large transaction size (a couple of million at least) and may come with high transaction charges (sometimes up to 10%), and longer lead times.
  • Another upcoming way is to list your shares on a secondary platform which then collates a set of shares and offers it to its existing investor network. The drawback here is that unless you are offering shares of very well-recognized startups, there may not be enough demand.

Taking an example of company XYZ. The Company was founded in 2010 and the founder owns 100% of the shares (complete ownership). Company raises 1M at the post-money valuation of 10Mn. Thus, the early-stage investor owns 10% of the shares and the founder owns the remaining 90%. Over the next few years, multiple investors invest in a company and the valuation of the company also rises. Founders and early investors have a large portion of their wealth locked in the company stock. Traditionally, the only way for them to liquidate their share was for the company to go public or engage in an M&A transaction. But now, they can opt to sell a portion of their shares on a secondary platform and enjoy the benefits of their labor while continuing to grow their company.

We at Torre Capital provide our investors access to best-in-class startups, and shareholders easy liquidity in two ways:

  • You can opt to list and sell your shares outright on our platform. Our investors are always looking for high quality opportunities to invest in.
  • If you don’t wish to sell your shares, or can’t because of restrictions, you can also secure a loan from Torre Capital against your shares.

With our broad network across the globe and many collaborations, we bring to our investors the best of opportunities while allowing startup shareholders fast access to liquidity.

Pre-IPO market comes with its own set of risks investors should be aware of

Private markets are growing and maturing at a fast pace but investing in the Pre-IPO private equity market and securities in the secondary market carries extra layers of risk over investing in public securities such as bonds and public equity. Some of the risks that a secondary market investor bear is:

  • Risk of IPO not going live or getting delayed

There is a small risk even with high growth unicorns that the IPO may not go through, or the company may further delay going public. This risk is generally mitigated by the discount at which the Pre-IPO securities are available. But the probability of not going live and the inability to find other exit options is always present.

  • Sudden reduction in liquidity or valuation because of black swan events

Take the example of Bytedance. Till December last year, you could not get hold of shares of Bytedance even at inflated premiums. Due to the happenings over the past six months, investors who came in the past 12 years might find it quite difficult to exit their investment. WeWork is another example that has been much talked about. Such situations can’t be ruled out completely. The secondary private market has an inherent liquidity risk as the number of buyers and sellers in the market is limited. Also, there is no one centralized platform or stock exchange with market makers.

  • Information Asymmetry

Private securities in the secondary market are not held to same reporting standards as those on the public side. This makes it much harder for an investor to evaluate a private company. Founders and managers holding the security have more information available than the buyer and have no big incentive to share the information in the market. This information gap adds the risk and impacts investor confidence in the secondary market.

In conclusion

We firmly believe that Pre-IPO markets for mature/unicorn startups is going to expand exponentially over the next 5–10 years, and investors should carefully examine the opportunities available. If suitable for their risk profile and portfolio size, this can be a great asset class to allocate 5–10% of your portfolio to in order to improve overall returns and reduce dependence on traditional investments.

– – – – – 

This article has been co-authored by Daksh Arya and Sargam Palod who are in the Research and Insights team of Torre Capital.

ESOP Financing: Access the capital you need to exercise your stock options

by Sandeep Kumar

Why ESOPs are given?

Employees are granted stock options for a variety of reasons. Stock options are more frequent in start-up companies that can’t afford to pay their employees significant wages but are willing to share in the company’s future success. In such cases, stock options are given to employees as part of their remuneration package. In some cases, the employee is also given stock options, which he can exercise at a later date/s, in order to ensure his long-term commitment. Employee stock ownership plans (ESOPs) assist to build a sense of belonging and connection among employees in addition to giving monetary benefits.

When a stock option is provided to an employee under an ESOP program, it is free. The ESOP scheme spells out the terms and conditions under which an employee can use his rights. After a specific lock-in time, which is usually more than a year, the employee’s option can be exercised.

How do they work – vesting portion

The right to exercise the option may vest in the employee at a later time. The “vesting date” is the date on which an employee becomes eligible to exercise his or her right to purchase shares. The rights may vest fully or partially over the vesting period.

For example, on 31 March 2018, an employee is granted 1000 options, which can be exercised in three phases: 20% at completion of the first year, 30% with completion of the second year, and 50% on completion of the third year from the date of the grant. So, in this situation, the vesting dates for 200 options are 1 April 1 2018, for 300 shares, 31 March 2020, and for the remaining 500 shares, 31 March 2021.

For such vesting, the plan may specify the same or a different grant price or exercise price. The grant price, or the price at which an employee can purchase a share from the company, is usually set and is significantly lower than the current market price of the shares.

It is not mandatory for the employee to exercise the option because it is only presented as an option with no obligation linked to it. In the event that the current price of the shares is lower than the exercise price, the employee can choose to execute the option or let it lapse. The employee is granted a certain amount of time to execute his option, after which his vested rights may lapse. The ‘exercise date’ is the day on which an employee exercises his option to purchase shares.

When options are granted, as well as when they are vested in the employee, there are no financial outflows or tax ramifications.

Exercising options: why, how much, and when?

If your current cash curve isn’t doing as well as you’d like, exercising stock options may be able to help.

Exercising, on the other hand, is an investment in terms of money. Is it therefore worthwhile to pay the price?

When executing options, you pay money to increase your cash curve. The more options you utilize, the more money you spend; nevertheless, the curve improves as you utilize more options.

The numbers will change depending on your situation. You boost your chances of making more money in the future by paying today. However, if your company fails, you will lose that money.

An employee’s option does not have to be exercised after it has vested in him. The employee has a certain amount of time to exercise his or her privilege. When an employee should exercise his or her options is a crucial subject from a financial and taxation standpoint.

The employee must pay the preset price for the shares when he exercises the option, resulting in a financial outflow. Because the shares cannot be sold unless they are listed on a stock exchange, the money is locked up until the shares are listed or the promoters offer you a way out. Furthermore, extending your exercise date has tax implications because the capital gain holding period begins on the exercise date. As a result, the decision must be taken carefully after considering the cash flow and tax implications.

You exercise your options and officially have shares

When it comes to exercising, you have complete control. As long as you work for the company, you can buy shares whenever you want, and you don’t have to buy them all at once. When you leave a company, you usually have 90 days to decide what you want to do next (a few companies extend this to 5, 7, or 10 years).

You can exercise closer to the exit and then pay for it with the money you earn, so there are no out-of-pocket expenses. However, there are a number of disadvantages to this method.

It’s a big decision to decide which tactic to use.

Your company exits – finally!

When a business closes, one of two things happens:

  1. It is acquired, which means that another firm buys it. Microsoft purchased GitHub, Amazon purchased Twitch, and Facebook purchased WhatsApp. It goes public, which means it sells its stock in an initial public offering on the open market (IPO). Slack, Uber, and Lyft have all done just that.

Employees usually have a 90- or 180-day ‘lock-up’ period after the IPO during which they are unable to sell their shares.

You can sell your shares for a profit if the company’s exit value is high enough.

Your alternatives would be pointless if you didn’t have a way out.

Determination of your shares’ exit value

Your cash curve determines how much money you’ll make if your firm goes bankrupt.

Your ISOs and NSOs are in place to make you money in the future. “Exit” was the moniker given to that particular day. This occurs when your firm goes public via an initial public offering (IPO) or is acquired by another company. The amount of money you receive if and when your company closes is dependent on how successful it has grown. Your company’s exit value is determined by its level of success.

Regrettably, the exit value is unpredictably variable. You’ll never know how much money you’ll make as a result of your efforts. The only certainty is that when the exit value rises, you will make more money.

When should you sell the shares?

Selling an ESOP stock is equivalent to selling any other type of investment. You must evaluate the capital gains implications as well as the need for liquidity when making a decision. The selection will also be based on the Company’s future prospects.

It’s also possible that the shares you purchased through an ESOP aren’t listed, in which case you won’t be able to sell them until they are, or until the promoters offer you an exit, which may or may not be under very favourable terms. It would be advisable to wait until the shares are listed on a stock exchange in this scenario.

Tax implications when exercising the option

The taxes of ESOPs have a common structure. It is subjected to two levels of taxation.

The employee’s option to purchase shares at the exercise price is exercised in the first stage. The shares are eventually sold in the second stage.

First stage, 

When an employee’s ESOP options are exercised, the difference between the exercise price and the security’s value is treated as a prerequisite in the employee’s hands. The employer must deduct tax from the employee who exercises the option at source, recognizing it as a prerequisite. If the shares are listed on any stock exchange in India, the value of the shares given to the employee will be the average of the market price (average of highest and lowest price) on the date the option is exercised. In that instance, the fair market value will be determined by the merchant banker’s valuation certificate. The certificate of share valuation must be no more than 180 days old from the date of option exercise. Even if the shares are listed outside of India, the Company must get a certificate from a Merchant Banker because such shares are considered unlisted for ESOP purposes.

Second stage,

When the employee sells his/her stock. Capital gains tax will be imposed if a sale occurs. Depending on how long the employee has owned the shares, the gains can be either long or short term. The holding time requirements for both listed and unlisted shares are different.

Starting from F.Y. 2016- 17, If the holding period is more than 12 months, the listed shares will become long-term. However, if the holding period is more than 24 months, unlisted shares will be considered long-term.

The period of holding begins from the start of exercise date and ends at the date of sale.

At present the long-term capital gains on listed equity shares (on a recognized stock exchange) is tax free, however, short-term capital gains are taxed at 15%. Let us explain!

When shares are traded through a broker the long-term capital gains are fully exempt under Section 10(38) of the Income Tax Act.  However, as per the newly inserted section 112A via Finance Act 2018, if the amount of long-term capital gain exceeds Rs 100,000 than the amount in excess of Rs 100,000 shall be chargeable to tax at 10% without indexation (plus heath and education cess and surcharge). However, the application of sec 112A is subjected to certain conditions, one of it being the transfer should have taken place on or after 1st April 2018. Moreover, such short-term capital gains shall be taxed at flat rate of 15% under Section 111A.

If the shares are not sold through the stock exchange’s platform, long-term capital gains are calculated by indexing the original purchase price. Indexed gains will be taxed at a 20% flat rate, plus any applicable surcharges and cess. Short-term capital gains are treated like any other form of income, and they are combined with other kinds of income and taxed at the appropriate slab rate.

For the purposes of computing capital gains, the cost of acquisition is treated as FMV (fair market value) on the date of exercise, which is taken into account for the purposes of perquisites of the options, rather than the amount actually paid by the employee.

Taxation of Foreign ESOPs

If a foreign company grants an ESOP to an Indian resident, the ESOP will be taxable in India. Furthermore, the tax regulations of the company’s home country, as well as the double taxation avoidance agreement, must be investigated in order to determine the actual tax implications. Furthermore, because these shares would not be offered on Indian stock exchanges and are unlikely to be listed in India, the long-term capital gains exemption under Section 10(38) or the concessional rate of 15% tax on short-term capital gains in respect of such shares would not be available. ‍ 

When you have incurred a loss

In case you have incurred a loss you are allowed to carry forward short term capital losses in your tax return and you are eligible to set them off against short term capital gains in the coming years. Long term loss on equity shares is a dead loss and has no treatment, simply because gains are not taxable as well.

Torre’s Offering: Non-recourse financing and how it benefits startup employees‍

Employees in private enterprises (like you) can execute stock options using non-recourse financing. Because the loan is non-recourse, your other personal assets are never in danger.

For example, if the loan is non-recourse, the lender accepts the risk and you are not required to put up personal assets as collateral, such as your automobile.

Before we get into the technicalities, let’s take a look at why financing is useful in the first place.

It’s usually better to execute your stock options as soon as possible rather than later. If your company grows, exercising sooner means paying less tax both during the exercise and after the IPO— which means more profit for you.

However, exercising options can be financially out of reach for many employees of high-growth businesses on the verge of an IPO or exit. Consider this: exercising options costs nearly twice as much as a household’s annual income.

Furthermore, as the value of start-ups rises, exercising options becomes more expensive and prohibitive. That’s because the higher your options’ 409a valuation, the more tax you could owe.

Non-recourse finance can aid in this situation. It works like a cash advance, allowing you to exercise your start-up stock options without having to pay for them out of pocket.

How it works?

The lender delivers you the funds you need to execute your stock options and pay your taxes. You wait for your company to go out of business. There are no monthly interest payments, unlike a traditional loan.

If your firm has a successful exit (such as an IPO), you repay the money you borrowed plus any fees. You owe nothing if your company does not exit or falls out of business entirely. The lender is responsible for the loss. Your other personal assets are never at risk because it’s non-recourse finance.

If you already own stock in your company, non-recourse financing might enable you to access cash for other financial goals, such as buying a house or diversifying your stock portfolio, without having to sell your stock.

Is non-recourse financing too good to be true?‍

So what’s the catch?

To summarise, non-recourse financing does not put your personal assets at risk, and the financing source bears all of the adverse risk. So, what’s in it for the financial service provider?

Case 1: The supplier benefits from your success: the more effective the exit, the better for everyone. In the end, the amount you owe is determined by the value of your equity.

For example, you have $100,000 worth of ESOPs and on a successful exit you gain $50,000 then a commission of 30% would be charged which is $15,000 plus the principal amount. Similarly, if your gain is higher let’s say $80,000 then you owe a charge of 30% of $80,000 that is $24,000 plus the principal amount, hence the amount you owe will be determined by your equity value at the exit event.

Case 2: The financing provider receives a share of your pay-out plus a return of the initial advance if you successfully depart (plus any interest).

Continuing the previous example along with the commission on profit x% of interest will be levied on the principal amount. Suppose you borrowed $80,000 for exercising the ESOP, x% of that amount will be charged as interest in addition to a $15,000 commission.

Case 3: The funding provider bears the brunt of the loss if the exit fails. There is no payoff for the lender to take a portion of, and you are not required to repay the original advance.

Carrying forward the previous example of $100,000 worth of ESOPs. Suppose, the exit the value of your position is $90,000 and you are in loss of $10,000. Hence, there will be no payoff to take commission and we will bear the loss without bothering the borrower. Plus, the borrower will not be required to repay the principal amount, nor his personal assets be liable.

We are ready to take such a risk because we are very selective about the companies we engage with —thus, the people we finance. As finance providers, we also diversify the risk by investing in multiple start-ups.

How Torre can help‍?

We’re on a mission to assist start-up employees and shareholders understand, maximize, and unlock their stock’s value. We offer non-recourse stock option exercise financing to help you reap the benefits of exercising your options early. We also offer financing alternatives that allow you to access the cash of your hard-earned equity prior to departure without selling your stock.

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