The dream of making it rich is an integral part of the Israeli high-tech narrative, and it’s a major reason that Israel has an unusually high concentration of startups and venture capital investments per capita. It’s not only the dream of company founders. Every year, for relatively low pay, thousands of talented workers join startups that are taking their very first steps – but they also get a generous options package, which bears fruit only if the company meets future success.
Oren Barzilai, CEO and cofounder of EquityBee, says options in the right company are nearly the only way for high-tech workers to change their economic prospects.
“If you earn 20,000 to 30,000 shekels [$5,600 to $8,400] a month, you’re still in the same [upper-middle-class] socioeconomic group, but if you joined a company like Datorama or Waze at the right time, you can buy yourself a house in cash. More and more workers are understanding that haggling over a few thousand shekels a month is less important than an options package and the chance of an exit,” he said.
Yet over the past few years, the role of options as a tool for recruiting and maintaining manpower has changed. Startups are remaining privately held for longer periods, and more and more private companies are attaining valuations of $1 billion or more (companies known as “unicorns”) before being sold off. As a result, more employees are facing a conflict. Unable to cash in on their options, they’re millionaires on paper, but only as long as they stay with the company.
An option is a contract that enables the holder to buy a share in a company at a pre-determined price. Employees with options can cash them in if the company is sold off for a stock price higher than the share price pre-determined in the option contract (the “strike price”). Their profit is the difference between the strike price and the company’s market price, multiplied by the number of options they hold. Generally speaking, options granted to a specific employee come due gradually, over a period of four years, meaning that workers may profit from an exit even if they’ve been with the company for only two years.
So long as the workers stay with the company, they’re under no pressure to cash in on their options. This method suits the technology industry, where startups are generally founded with the intent of being sold off or launched on the stock exchange within a few years. But nowadays, with unicorns no longer being so rare, founders are extending the period during which companies are kept private, sometimes for more than a decade.
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Employees who leave a startup are generally given 90 days to cash in on options that have matured – converting them into the company’s stock in exchange for paying the options’ strike price – or not exercising the option and foregoing any future compensation for an exit. Depending on the options package, cashing in on options can be an expensive proposition, ranging from $5,000 to hundreds of thousands of dollars. EquityBee says the average options package costs $67,000 to cash in on, while the median package costs $27,000.
The major risk is that most Israeli startups never attain an exit, and those that do aren’t always sold for more than was invested in them. It’s therefore no great surprise that some 75% of employees choose to forgo their options when leaving a company. But what if you could let someone else – an investor – take on the risk while benefitting from any future payoffs? That’s what Barzilai and his EquityBee cofounders Oded Golan and Mody Radashkovich are seeking to do.
EquityBee is a platform that links investors and departing high-tech workers, allowing the employees to obtain funding to cash in on their options without taking on the accompanying risk. For the investors, this is an opportunity to invest in a privately held company that they wouldn’t have access to otherwise; while for the workers, it’s a chance to realize some of the potential gains that they would have otherwise had to forego.
EquityBee charges the investor a fee when the options are initially cashed in for shares, and charges both the investor and the former employee a fee if the company has an exit. Both the investor and the worker sign a contract with EquityBee, but they are not directly in touch with one another. Barzilai and Golan say they got the idea for EquityBee when they received a buyout offer for their first startup, Start A Fire, a platform for content marketing.
“We received an offer to buy the company for $18 million, and the two of us held most of the company’s shares, and it looked very good on paper,” said Barzilai. “But there was a little clause that said the payment would be in shares [of the acquiring company]. The buyer was a privately held company, so I tried to figure out what I could do with the shares of a privately held company. The deal ultimately fell through over this. We later heard about friends who had left companies and debated whether to cash in their options for shares in the companies, which were privately held, and therefore learned about this conflict holding employees back.”
Barzilai and Golan are childhood friends. They both did their Israeli army service in technology-related positions. Barzilai has a bachelor’s degree in math from Tel Aviv University, while Golan has a bachelor’s in computer science and an M.B.A. from the Herzliya Interdisciplinary Center. Barzilai was a founder of Tapingo, a company that offered food delivery services on U.S. college campuses. It was ultimately acquired by U.S. company, Grubhub, for $150 million at the end of 2018. He left the company in 2012, before the exit.
The third partner in EquityBee, Radashkovich, joined more recently after a decade at the publicly traded real estate firm Gazit Globe, where he was CEO of Gazit Germany. He met Barzilai while studying for a computer science degree at Tel Aviv University.
Since its founding last year, EquityBee has raised $1.7 million from private investors, including WeWork founder and CEO Adam Neumann, and Playbuzz founder and CEO Shaul Olmert.
In theory, EquityBee’s platform should benefit workers, their former companies and the local startup industry as a whole. In an article entitled “Unicorn Stock Options – Golden Goose or Trojan Horse,” Dr. Anat-Alon Beck of New York University explains that unicorns have created two classes of employees. One group consists of those who were with the company from its early stages, who have stock options worth millions, and who have stayed on instead of jumping ship and founding competing companies or bringing their experience to competitors, as was once commonplace. The second is those who joined at a much later stage with the knowledge that they are at a company worth an astronomical sum that few buyers can pay, and that they are unlikely to benefit significantly from any options they have received. The latter group often leaves their companies within less than two years, Beck said.
But EquityBee’s solution has created a conflict by upending the order of things in the high-tech sector. If more workers leave with a portion of the company’s shares, their options aren’t returned to the company’s option pool, and the number of options available to distribute to new employees or as bonuses to current employees shrinks. This is healthy, Barzilai claims.
“I think there’s a market distortion. A worker who joins a startup is told ‘Come help create value and in exchange, you’ll receive part of the future payoff,’ but under the current market conditions, the worker can’t really receive her portion of the value she’s created,” he said.
And what about the investors in startups? This waters down their holdings and runs contrary to their interests. The more you succeed, the more you’ll force companies to think of alternatives to options.
Barzilai replies: “It’s contrary to the investors’ interests, but the investors’ interest is also that the company not have its offices in Tel Aviv because it’s expensive, that it not offer employees 10bis [lunch credit at restaurants], and that salaries be a third of what they are.
Currently, the privately held companies have a problem. They have to compete for talent against publicly held giants like Google and Facebook, which can use their stock as currency for the payment of salaries.”
In the United States, it’s commonplace that options contracts forbid secondary sales of the shares. How does that impact your model?
“It doesn’t affect us because the shares don’t change hands. Instead, there’s a contract governing future division of profits.”
Ultimately your innovation is based on contracts, not technology.
“It’s based on contracts when it’s one-on-one, but when you want to do it on a larger scale – when you want to get to hundreds of deals a month and build your own platform, based on a database containing hundreds of companies, to evaluate the value of their shares – that’s already a matter of technology.”
EquityBee has registered a few hundred investors. They need to meet the Israel Securities Law’s definition of liquid investors, meaning they have 8 million shekels or more in the bank. The platform asks them whether they are interested in specific companies. Their answers give an indication as to what companies are perceived as having the best chance of highly profitable exits.
The most sought-after companies are Payoneer, which offers small companies a digital platform for receiving pay from international customers, similar to PayPal; Sisense, which has a platform for analyzing business insights and data; and WalkMe, whose platform enables other web-based services to teach users how to use their products.
Other companies that interest EquityBee’s clients include Via, a smart public-transport system; and Houzz, a platform for home design ideas and commerce; WeWork; and Taboola.
EquityBee plans to expand into the United States in the near future and is preparing the legal groundwork. Barzilai says Israelis love to complain, but adds that Israeli high-tech workers have a serious advantage when it comes to their options compared to their Silicon Valley counterparts.
In the United States, he notes, employees are liable for tax when they turn their options into shares, even if the gains are only on paper. In Israel, the tax is due only when the shares are sold for profit.