Down Rounds: How to Strategically Adapt Your Share Option Plan During Volatile Markets

The first half of 2024 has been challenging for private companies, to say the least. The IPO landscape is lagging, and the cheaper money many are waiting for still hasn’t shown itself, in the most dominant economies anyways. 

Trends certainly haven’t been identical across the board, though. We’ve seen certain market sectors, like AI, explode, and indices have been dominated by a handful of players within a few well-performing companies.

The combination of expensive money and uncertainty has had a big impact on VC funding, and many private companies have been forced to make strategic adjustments to their Share Option Plans. In this guide, we’ll walk you through a number of strategies that private companies could implement to adapt and maintain their Share Option Plans during a volatile market.

Which category are you in?

During H1 '24, private companies within a hyped market segment or those with outstanding profit generation capabilities experienced déjà vu of the magical 2021-2022 period. The Founders held most negotiation power, and there was no significant impact on their option pool. 

Businesses outside of a hyped market segment found themselves in a different situation. We’ve pooled these businesses into two categories.

1. Businesses with NO immediate fundraising needs.

These companies have geared up for the pilgrimage to profitability. They need to be resourceful because the option pool created during their last fundraising round now needs to last much longer than anticipated.

2. Businesses that need a cash injection. 

If these companies are skilful enough to find willing investors in a tough market, one of three scenarios will play out. 

1. Some will manage to raise funds at an increased valuation compared to their last round. For their option pool, it will be business as usual. 

2. Some will manage to raise funds at a similar valuation to their last round, which will have no significant impact on their option pool. The pool will still be topped up, and the lack of value growth can be reasonably explained by strong Founder-led communication that outlines the impact of the macroeconomic environment. 

3. Some will manage to raise funds at a decreased valuation compared to their last round. These companies will find themselves in a tricky situation. If they leave their option pool as it is, new joiners will suddenly receive more options than legacy employees (which won’t be well-received). 

They, therefore, have three common remedies to choose from.

Option 1: They could NOT decrease the share price when calculating grants. Those impacted can be reassured through Founder-led communication that this is not a result of company performance but rather due to unfortunate macroeconomic conditions. 

Option 2: They could lower the strike price for legacy employees IF their tax valuation AND previous strike price level allow. This means their options will not be worth as much as they were during the last fundraising round, but at least they won’t be underwater (out of money). 

If Option 1 fails and Option 2 is not feasible due to a detrimental impact on the award’s tax treatment for the company and the employee, there is a third option. 

Option 3: They could true up legacy grants by offering more options to legacy employees. By choosing a likely exit valuation, they could adjust the number of options to make a legacy employee’s payout the same as a hypothetical employee (with the same holding level, team, and geographical location) who had joined after the round. 

How can you make your pool last longer?

Whether you have no immediate fundraising needs or have managed to secure some funding during H1, the market’s uncertainty means it’s crucial to make your pool last. Many VC-backed Founders are, understandably, attempting to stretch their pool until exit. 

To do this, several strategies will decrease your option burn rate. 

Granting more-to-less and less-to-more. 

If, in contrast, you have chosen a company-wide equity ladder in which all departments and levels receive the same percentages, you could introduce tier-based banding. Split each department and level into two to three tiers with different equity multipliers. 

Decreasing the size of initial grants and over-indexing refresher grants.

This is a great strategy if you’d like to invest equity with your HiPos and use milestone- or performance-based vesting. 

We can see a version of this in practice at the likes of Google, Uber, DoorDash, and Pinterest. They decrease the initial grant for employees but sweeten the deal by making the vesting schedule front-loaded. At Google, this is 38-32-20-10 for the 4-year vesting period.

Then, instead of locking in a single stock price for the whole vesting period, they issue refreshers and reprice options in the latter years to reward high performers and let non-performers walk away or take a hit on their compensation.

Repricing your options every 6 or 12 months. 

This strategy can be applied in tandem with any of the strategies above but will only be successful in growing companies. There are two ways to do this. Firstly, you could use a board-accepted pre-set repricing mechanism. In this instance, you can share as much or as little about the valuation model with your employees, depending on your compensation philosophy. Secondly, you could engage with an external service provider to reprice your options. Remember, though, that if your valuation grows, you will be forced to hand out fewer options to maintain the monetary value of your grants.

Don’t forget about your budget. 

Distributing ownership to employees is a fantastic initiative, and doing your best to maintain a competitive Share Option Plan during a volatile market is admirable. Regardless, it’s crucial to keep tabs on the limitations of your employee equity pool and think about whether it would be feasible (or strategic) to increase it if necessary. 

Before making any significant adjustments to your Share Options Plan, make sure that you can afford it by asking yourself three questions:

1. How big is our currently unallocated employee equity pool?

2. Would I be comfortable asking the board to increase it?

3. How far does this budget need to stretch? (When do you anticipate the next material event, e.g., investment with pool top-up or liquidity?)

Conclusion

In a volatile market like the one we’ve witnessed in the first half of 2024, private companies need to be both strategic and adaptable with their Share Option Plans. As the IPO market remains sluggish and cheaper money is yet to show its face, companies must tailor their approach based on individual financial circumstances. Whether you’re a Founder in a hyped market segment or one facing tough fundraising challenges, we’ve proposed several strategies that, combined with careful budgeting and clear communication with employees and stakeholders, will help your company thrive, even during uncertain times.

Spela Prijon is a co-founder at EquityPeople, a specialist consultancy focusing on helping clients design the right incentive scheme for the stage of their company, forecast pool burn properly and educate key stakeholders. Connect with her and her co-founder Tamas on LinkedIn.

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