In recent years, many startups have boasted sky-high valuations, often accompanied by an abundance of cash reserves. However, this trend is beginning to show signs of cracking, as indicated by data from Carta, a startup equity infrastructure platform. According to Carta’s findings, the number of employee stock grants being repriced due to lower internal valuations has surged dramatically in Q3.
The Rise of Repricing
Carta’s data reveals that a record 18,629 startups re-priced their employee stock grants in Q3, representing a staggering 260% increase from the 7,165 re-pricings seen in Q2. This uptick is a significant departure from previous quarters, with only Q2 2020 experiencing a comparable number of repricings (12,570). These numbers are cause for concern, as they suggest that startups are finally acknowledging the need to adjust their internal valuations downwards.
The Role of Employee Stock Grants
Employee stock grants are an essential component of many startup compensation packages. These grants are tied to a company’s 409A valuation, which is a third-party appraisal of its fair market value. When a company re-prices its employee stock grants, it’s typically because their internal valuation has decreased, making the original grant packages less attractive.
Why Repricing Matters
Repricing these grants serves two primary purposes: first, it ensures that employees’ compensation is accurately reflected in light of changing market conditions; second, it provides a more realistic assessment of the company’s financial health. As Peter Walker, Carta’s head of insights, noted:
"If you joined a company in 2021 and received stock options, now, in 2022, because of everything going with the economic climate, it is somewhat likely that the value of the stock that you got may be lower than when you joined. We would call those underwater shares."
Consequences for Employees
The re-pricing of employee stock grants can have a significant impact on employees, particularly those who are "underwater" (i.e., their options are worth less than the original grant). This can lead to decreased morale and a sense of unease among staff members. Walker emphasized that this trend is likely to continue in the coming months:
"I think it probably comes down to just dynamics within these companies and their fundraising pathways… Perhaps companies were trying to not value themselves or get a new 409A but now need to for a bridge round or different financing options."
The Decline of Exercised Options
Carta’s data also reveals that the percentage of employees exercising their stock options when leaving the company has been steadily declining this year. Walker attributes this decline to rising interest rates, which make it less attractive for individuals to exercise options and put out cash or take on debt.
A Worsening Trend Ahead?
As valuations continue to drop, layoffs are likely to become more common. Walker predicts that the number of employee stock grants being repriced will only increase as companies struggle to maintain their financial stability:
"The trend is clear: startups are facing a perfect storm of economic uncertainty and declining valuations. It’s essential for founders and investors to acknowledge this reality and adapt their strategies accordingly."
Conclusion
The recent surge in re-priced employee stock grants serves as a warning sign that startup valuations may be due for a correction. As the economy continues to navigate uncertain waters, it’s crucial for startups to prioritize transparency and communication with their employees. By doing so, they can mitigate the negative consequences of lower valuations and ensure that their teams remain motivated and committed to the company’s mission.
Additional Resources
- Carta’s Q3 2022 Report: A comprehensive overview of Carta’s findings on employee stock grants and startup valuations.
- The Impact of Repricing on Employee Morale: An in-depth analysis of the psychological effects of re-priced options on employees.
- Strategies for Mitigating the Consequences of Lower Valuations: Expert advice on how startups can adapt to changing market conditions and maintain their financial stability.
