Playing with fire

I was responding to a Twitter thread in which a former CFO mentioned that he was burned by his company’s stock despite being a promising startup coming out of Y-Combinator. He had used a non-recourse loan to exercise his stock options through an existing investor on his company’s cap table.

Unfortunately, things didn’t work out and the loan ended up being underwater. Not only did he not make a penny off his stock options, but he was also stuck with a tax bill on the forgiveness of debt from his loan.

It was an unfortunate situation that happens more than we’d like to admit. Most companies actually fail despite what this market is portraying.

I had a few takeaways from reading this thread.

First, don’t risk what you can’t lose. Avoid financial ruin at all costs. The positive note for this individual was that at least the loan was non-recourse meaning that he didn’t come out of his savings to pay for the stock. In the last couple of years, I’ve seen individuals do some insanely risky loans and plays in order to exercise their stock options. Some take a second mortgage on their home. Some get as much recourse debt as possible.

This is playing with fire. Things may work out and you’ll forget this advice. On the flip side, this could result in you losing your home and potentially financial ruin. None of the upside is worth that downside. If you’re taking recourse loans or using your savings, make sure to not bite off more than you can handle.

Second, structure absolutely matters. Not all financing is made the same. If this individual had worked with a provider that structured the contract in a much more favorable way, he may not have a tax bill at all. In all likelihood, his taxable gain would’ve been washed out by his losses on his stock. He’d still be at a net 0 position, but that’s better than losing money on the stock.

I know I am biased here as I work for Secfi, but everyone needs to understand what they’re getting into and the potential downsides.