Tuesday, April 14, 2020
Interview with Greg Martin, LiquidStock
Our interview today is with Greg Martin, co-founder of LiquidStock (www.liquidstock.com), an investment fund which offers up a way for employees of private companies to exercise their stock options before an IPO or acquisition. Greg—a longtime veteran of venture investing—also shared his thoughts on the current pandemic, how investors are viewing the current market, and what startups can do now to survive through these unusual times.
Tell us what you're up to now?
Greg Martin: I raised a fund called LiquidStock, with three partners. We closed in January of 2019. LiquidStock is a fund that is geared towards employees of private technology companies, enabing them to exercise their options, cover their taxes, and use their shares for their liquidity needs, using a non-recourse structure. Basically, we're advancing them cash, and the only collateral is their shares. That takes any personal risk they have off the table, because the recourse for the financing are only the shares. We raised $160M, and our core limited partners are Goldman Sachs, Morgan Stanley, and Coller Capital. They are all big, institional investors.
Why did you start LiquidStock rather than a more traditional venture fund?
Greg Martin:I still have a venture firm, Archer Venture Capital, and continue to invest in later stage venture cpaital opportunities. However, as companies have stayed private longr, I saw there was a trend happening. I have seen employees how have a lion's share of their net worth tied up in options, and have a very difficult time to exercise those options. But, not only is the cost of exercising them costly, in terms of shares times exercise price, but the tax effects of those exercises tends to be even more dramatic. Very few employees can exercise their shares, and begin to own them, which gives them a peace of mind, god forbid something happens. Plus, they are not able to participate in the more favorable long-term capital gains rats that you get when you exercise your shares earlier. What ends up happening, is people do not exercise their shares until right before they sell them, and they basically sell and exercise at the same time, which means they end up paying the short term capital gains rate, which is a bit higher.
If you think about our product, there are basically three use cases. One, is there is tax planning, early exercise in order to participate in long term capital gains at a lower tax rate versus that short term capital gains rate. Two, is to have the peach of mind of share ownership. That's less relevant for a company, but right now this might be particularly relevant, as there could be layoffs and folks are going to want to exercise their options at a time when they don't have liquidity to do so. We have a really elegant solution to do that. Three, is the ability to use shares for liquidity. For example, if you want to buy a house, send your kids to a private school, or take a vacation, we allow them to unlock value from options that you hold, using our financing structure. It's very tax efficient. I have noticed this problem sitting on boards for many years, where people have come to me when they're leaving a company, asking them to buy shares from them in a secondary transaction. Though that is inefficient, a lot of times people believe in the upside of the company, and selling shares to get liquidity to cove the costs of their options and exercises is not the best option for them, because they lose out on the future value of an upside in a company. With our product, they retain much more of the future value of the upside value of the company.
We felt there was a real void in the market for this, which is why we raised the fund and spent a lot of time crafting the product for people. Some other folks have products along this line, but they have their own set of issues. We're very aligned with employees, in terms of having them continue to cheer the success of a company, and we're also good for the company, because the employee when they exercise still has stake in a company's success, whether they are in or out of the company. We, as investors are aligned, because when we exercise stock, we are providing capital to the company in terms of the exercise price. It's really a win-win-win product. Particularly in this environment, when the need for short term liquidity because of the economic challenges, or whether people need to leave a company, and have the need to exercise their in-the-money options, we are here to solve the problem for both employees and companies.
Is there a specific criteria for which companies you will do this for?
Greg Martin: The criteria is primarily about time to liquidity. We're looking for companies who are within two to three years of a liquidity event, whether that is an IPO or an M&A transaction. It's the more mature businesses, for sure. We also are looking for a situation where we can get some kind of scale, in terms of the total amount of financing we can get into a business. We would like a minimum of $5M to $10M minimum invested in any one company. Certainly, we can do smaller deals on an individual basis, around $100,000 in size, but we want to aggregate a number of employees to get up to that $5M to $10M minimum total size into a company. That's because we have to spend time evaluating the company itself, which is a certain amount of work, to make sure we're comfortable that the company will advance our financing product. So, there are some hurdles in terms of liquidity and maturity of business, which I think is the most important criteria.
Do you end up working with companies in order to get those minimum amounts?
Greg Martin: We have worked, in many cases, with the top executives of those companies. Obviously, that's a starting point, and as we get scale in terms of people who have those problems, they tend to be those where stock ownership I s a lot higher, so the deal size is already significant as it relates to those individuals. We are also talking to companies doing programmatized plans, where they offer this product to all of their employees. Because of our capital partners, that's something we can offer. That's the reason we have substantial capital backers behind us, beyond the size of the fund. We are absolutely working with the companies, top executives, and even individual employees. We also are working with investors, who might need to provide some liquidity or have GP commitments, and we can provide early liquidity for invstors without selling their shares, the same way we apply these to employees.
How has the world situation right now changed what you are doing?
Greg Martin: There is before corona and after corona. If you look at LiquidStock before corona, there is a portfolio of investment we've already made. We have to evaluate those past investments, looking at our past deals and seeing how this affects the value of those deals. Fortunately, we made investments in strong companies which may benefit in the end from COVID-19, companies that are well suited to weathering the storm. From an existing portfolio perspective, we only have deployed a small amount of capital, and still have $120M of dry powder left. We feel very good. Obviously, we'll have to evaluate some of the valuation compression on those existing deals, but we don't feel any of the companies are at risk in terms of going out of business. Looking at opportunities going forward, we have a lot of capital to invest out of our first fund. That's where we are really spending time, trying to get a feel for which companies to make investments, not just based on the near term, but what we think will be the new normal of how people live, purchase information technology, and who the winners and losers will be from what's happening right now. We're thinking more long-term than short-term. How are people going to act after this? We're spending a lot of time figuring out companies we would want to offer our product to. At the end, we're investors, an though we're providing a solution for individual shareholders, ultimately, that is backed by the equity in the company, so the company is paramount to what we do. In an environment like this, we think a lot of people would like the peace of mind owning shares of their company. In a liquidity-strapped environment, unfortunately, not a lot of people have that ability, and unfortunately, if you are let go from a company that might even be more acute. Not only do we offer a way to make sure you can own the shares, even if you don't have the cash, you might also want to use those shares for some liquidity to help you in a time where the economy isn't what it used to be. We feel that if we do a good job of being involves with the right set of companies, we both have the ability to help employees solve that tax planning, ownership, and liquidity issue, it's a win-win for them, the company, and our investors.
Having been through several up and down cycles through your career as an investor, what advice would you give to companies and startups right now?
Greg Martin:I sit on several boards through my other funds. My first piece of advice to everybody, is survival is paramount. Cash is king. Anything you can do to survive and sustain your business operations, to keep your team together, that is the most important thing. You don't need to talk about growth. Growth is not important. Survival is the most important thing. We don't know what is going to happen, how long this economic shutdown is going to last, what life is going to be like in the new normal. You have to figure out how to survive. That's the only thing that matters. Cash is king, so shore up your balance sheet as much as you can. Reduce your expenses, which is obviously incredibly important, and have a single focus on survival right now. Obviously, that means different things for different companies depending on their life cycle. However, if you survive, you will be in a great position to thrive. We've seen that through a few cycles before. The survivors end up stronger. What doesn't kill you makes you stronger, as the saying goes. I think that's particularly true in situations like this. You will have less competition, you will have more loyal employees, and you will probably have created a much more lean and mean operating environment in your company. That will enable you to operate better in the future. I've seen it time and time again, companies that get through difficult patches come out stronger. It's a tough message, obviously, because reducing costs has a lot of emotional toll. When you're letting go of employees and reducing perks, it's not an easy thing for people to do. However, the rewards of doing it are clear. The most important thing, is to be three when things start to get going again, because there are rewards at the point for those that survive.
Thanks!