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Equity pooling is an important new tool for founders and employees to protect their wealth. It can make all the difference in how they grow and protect the value of their stock and options.
Equity pooling allows you to trade part of the value of your stock or option position, for ownership in many other similarly promising companies. In a way that is easy, simple, and involves no cash. It is accessible and applicable to everyone, from founders to employees.
In this article, I’ll explain
“Wealth management” is any activity one takes to better protect their resources and families. It’s something that we engage in all of the time (whether we want to or not).
Wealth management ranges from our spending decisions, to our investment decisions. For example,
We are constantly making decisions and trade-offs about every aspect of our financial life. Yet, there is one area of our finances where we remain unable to make many decisions, despite the importance of those assets. And that is – our positions in illiquid, private market startups.
Founders and employees often have a substantial portion of their net worth tied up in these businesses. Yet, they have limited options to manage that wealth.
They must sit with massive exposure to a single, speculative business. Then they must wait, hoping that this asset, which may be 80%+ of their net worth, materializes into something.
They would be much better served by some diversification – even if they believed in the core business that they are exposed to.
That is because diversification is a critical part of any wealth management strategy.
One of the most important principles of wealth management is diversification. Diversification is the act of spreading one’s resources among disparate holdings. Since they are less likely to all succeed and fail in unison, one is less likely to get “wiped out”.
Diversification is the most reliable way to protect one’s equity downside and avoid the risk of total loss. And in the risky world of startups, with 92% of equity being worthless – there are few better markets to diversify.
A closely related benefit of diversification is that it eliminates volatility.
Volatility refers to the likelihood, frequency, and degree to which a certain outcome will be different than its expected value.
Startup equity is very volatile. It may have a high value on paper. But we are well aware that its real value may very well be zero (or substantially more).
An employee with substantial startup equity would be well-served to diversify, if they could, and reduce the volatility of the paper position. Even a small portion of their holdings could be a massive benefit to their family, worth years of salary. The certainty of realizing just a portion of their paper wealth could make all the difference in the world.
Yet, the current system forces them to treat things as an “all or nothing” bet.
Imagine if your concentrated stock position was in a public company, like Apple, Disney, or Microsoft. The idea of being unable to shift part of that position into another stock would seem crazy! And these businesses are much more stable than startups.
Yet, this is exactly what startup employees are forced to do. They cannot diversify or reduce the volatility of their large paper position.
But if they use equity pooling, they could protect themselves from the risk of complete loss. Similar to an insurance policy.
Equity pooling injects responsible management into your stock and option positions.
Let’s consider how the world of wealth management for public stock works.
A prudent financial advisor would encourage one not to make a very large gamble on a single holding – even if you had strong belief in that business. Sure, they’d recommend some outsized exposure, if you had substantial conviction. But primarily, they would guide you to invest in index funds, or at least, to a well-rounded portfolio of many strong, well-established businesses.
In other words, in spite of any given large business being mature, there's too much volatility and uncertainty to rely on a strategy that doesn’t incorporate diversification. Especially in light of historical data that suggests that active fund managers cannot even beat a diversified portfolio of the S&P 500 index!
If public fund managers cannot beat such an index, in spite of all of the available information, expertise, and resources - why should we expect unprofessional players in the private market ecosystem to be any more successful?
We are forcing stock and option holders to engage in wealth management, in a game that favors a different sort of bet (indexes and diversification).
What's even worse from a wealth management perspective is that employees cannot even choose the companies they want to bet on! Meanwhile, investors, who can choose from thousands of startups and yet can only pick a dozen, still have most of their bets fail!
Employees are trying to put food on the table. Optimizing for the probability of their startup equity succeeding cannot be their only consideration, like a professional investor.
Yet, the holding is meaningful enough that they should be entitled to act rationally and diversify.
This is not a good system for employees to build and manage their wealth. They are receiving substantial equity grants and being forced into a mathematically suboptimal way of harvesting their wealth, without any solid justification.
But if they use equity pooling as part of their holding, they can manage that wealth according to a conservative, data-driven approach. Without compromising on the “dream” of their equity having major upside.
We've established that:
Now, anyone can go from a single concentrated position to a diversified, less-volatile index.
If any of this resonates and you want to go deeper – sign up with Apeiros, so that we can tell you more about equity pooling and help you make the best use of this important new tool.
And share this post with any founder or employee that you know, who would want to learn about a new way to inject more security and stability in their financial life.
Aaron is a Chief Investment Officer & Co-Founder at Aption. Prior to Aption, Aaron was an experienced and accomplished VC, serving as a General Partner with Aleph, and prior to that, as an investor with Insight Partners.