(This story was updated on May 26, 2022 with information about layoffs at Bolt Financial.)
 
Amid the tightest labor market in decades, the biggest obstacle faced by most companies is attracting talent.

To stay competitive, private companies are not only offering higher salaries to potential recruits, but also luring workers with larger equity compensation packages, often in the form of stock option grants. According to Jody Thelander, founder of compensation-focused firm J.Thelander Consulting, the trend has accelerated in recent months. 

Yet exercising vested stock options and paying the associated taxes is expensive. For employees who can't afford to pay out of their own pockets, the question of how to finance options purchases has become more pervasive as startups stay private longer. And with the number of startups growing all the time, it is also becoming more widespread.

The issue gained fresh attention (and scrutiny) following a recent offer by Ryan Breslow, founder of checkout technology provider Bolt Financial, to extend loans to his employees to exercise their options. The risks surrounding that idea came into focus again in late May, when Bolt handed layoff notices out to one-third of its employees, reportedly including some who had accepted the options-financing offer.

While exercising options in a fast-growing startup could lead to great wealth, paying out of pocket or financing the transaction with a loan can be financially risky for employees. The company might never reach an exit, and even if it does, it could be valued lower than employees' option strike price. That's likely the case for some workers of newly public companies whose stock prices have plummeted—in some cases below their IPO prices.

To help counter these risks, venture-backed startups and firms structured as private funds have started offering employees of promising startups a loan-like product for purchasing stock options. EquityBee, SecFi, Liquid Stock, Quid and ESO Fund are just some of the companies that offer the products.

A type of non-recourse loan, the products give the employee the money to exercise their options in exchange for a certain number of shares—or their cash equivalent—if the startup is acquired or goes public. If the exit is successful, the employee will share their profits with the provider financing the stock options purchase. But if the startup fails or exits below the option strike price, the employee can walk away.

"We know how to price these deals in a manner that creates a win-win situation" for us and the employee, said Greg Martin, a co-founding partner at Liquid Stock, which is currently investing out of a second fund expected to be significantly larger than the firm's $161 million first vehicle.

While employees give up a portion of their upside in exchange for financing from one of these providers, many pre-IPO companies choose to refer their employees to an outside vendor rather than extend loans directly, according to Martin. The borrower-creditor relationship between the employee and the company, he said, could potentially turn toxic.

Providers of these products sometimes ask for 40% or more of the financed equity in return for financing the exercise of options. But in many cases, employees are asked to give up significantly less, and the cost of the product could be worth the peace of mind, Martin said.

Oren Barzilai, co-founder and CEO of EquityBee, a marketplace that connects startup workers with investors who bid to finance the purchase of stock options, said employees need a strategy to address the potential overexposure of their finances to one asset: their employers' stock.

"Employees should think like investors" when it comes to diversification, Barzilai said.

As the startup ecosystem expands, non-recourse stock option funding products seem likely to gain prominence, but providers of this kind of financing say that many employees aren't aware that it exists. Since stock options typically must be exercised within 60 to 90 days after an employee leaves a company, many options go unexercised. There are also tax benefits to buying stock options earlier, which can sometimes allow employees to hold shares long enough to qualify for lower, long-term capital gains tax rates.

EquityBee estimates that about $60 billion in stock option value becomes available each year and about 55% of it is not exercised.

"Our main competitor is lack of knowledge and education about this,"  Barzilai said. Employees of startups that have raised at least $50 million in funding from known VCs are generally eligible to offer their options on EquityBee's platform.

Liquid Stock's Martin also said he wants to raise awareness about the solution.

"What we really should be thinking about is ways to help employees exercise their options," he said. "But let's do it in a manner that doesn't create an uncomfortable conflict between the company and the employee."

Related read: IPO bonanza leaves out some tech workers over unexercised stock options

Featured image by Randy Faris/Getty Images

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