Startup Equity as Collateral: What Lenders Need to Understand

The Liquidity Problem

Jane is a senior engineer at a pre-IPO company worth $10 billion on paper. Her vested equity stake is worth $2 million, but she can't sell her shares because there's a right of first refusal, no active secondary market, and a blackout period. On paper, she's wealthy; in practice, she's cash-poor.

This is the invisible wealth crisis. Millions of technology employees hold significant paper wealth in forms that traditional banks cannot see, let alone value. Pledged-asset lending offers a solution, but the various forms of startup equity present very different collateral characteristics.

Types of Startup Equity

Restricted Stock Units (RSUs)

RSUs are promises to deliver shares at a future date, typically upon vesting, meaning the employee owns nothing until vesting occurs.

Vesting Reality: Usually 4-year schedule with 1-year cliff, monthly or quarterly thereafter. If Jane leaves before the cliff, she gets nothing; if she leaves after, unvested RSUs evaporate.

Tax Treatment: Taxed as ordinary income upon vesting, with the company withholding by selling shares. This matters because the employee never sees the full grant, as a portion is liquidated for taxes immediately.

Lending Implications: Unvested RSUs cannot be pledged because the employee doesn't own them yet. Vested but undelivered RSUs may be pledgeable depending on plan terms. Post-delivery shares are standard equity collateral, subject to transfer restrictions. The distinction matters because a borrower with $500K in RSUs might have only $200K in vested, deliverable shares, and those shares may be subject to ROFR.

Incentive Stock Options (ISOs)

ISOs provide favorable tax treatment if the employee jumps through specific hoops.

Tax Treatment: No tax at grant or exercise if held. Capital gains treatment requires holding 2 years from grant and 1 year from exercise. Disqualifying disposition creates ordinary income, and AMT lurks at exercise.

The Exercise Challenge: To get shares, Jane must pay the strike price. If her options have a $10 strike and $100 current value, she needs to come up with $10 per share to exercise, and sourcing that cash is often the problem.

Lending Implications: Pre-exercise options are essentially unpledgeable because no asset exists until exercise. Exercise financing is actually a common borrower need, providing cash to exercise options. Post-exercise shares remain subject to holding period requirements and transfer restrictions.

Non-Qualified Stock Options (NSOs)

More flexible than ISOs, less tax-advantaged.

Tax Treatment: Spread taxed as ordinary income at exercise, no special holding requirements, company gets a tax deduction.

Lending Implications: Same exercise financing needs as ISOs, but without tax-driven holding period requirements, though still potentially subject to company-imposed restrictions.

Common Stock (Founder/Early Employee)

Founders, early employees, and option exercisers may hold common stock directly.

Characteristics: Direct ownership, but may have vesting (founder vesting) and is almost certainly subject to transfer restrictions and ROFR.

Lending Implications: More straightforward as collateral than options or RSUs because the employee actually owns something, though still subject to restrictions that affect lender's ability to liquidate.

Valuation: The Hard Problem

409A Valuations

Private companies must obtain independent 409A valuations for equity compensation purposes. These valuations update annually (sometimes more frequently), use methodologies appropriate for illiquid private companies, may differ significantly from the last funding round price, and reflect common stock value, which is typically 20-40% below preferred.

For Lending: 409A provides a reference point, but it may be stale and is almost certainly lower than what the employee thinks their equity is worth based on the latest headline valuation.

Funding Round Valuations

When the company raises at a $10 billion valuation, that's the preferred stock price with liquidation preferences, anti-dilution protections, and other terms that inflate the number.

Common stock is worth less, often substantially less, with the "discount" ranging from 20% to 40% depending on company stage and capital structure complexity.

For Lending: The borrower says "my equity is worth $2 million based on the Series D price." Actual common stock value: $1.2-1.6 million, before illiquidity discount.

Secondary Market Transactions

Some pre-IPO companies have active secondary markets through Forge, Equityzen, Nasdaq Private Market, and direct transactions between shareholders.

When available, secondary prices are the best evidence of value, but the market is thin, sporadic, and usually subject to company approval.

Practical Approach: Start with most recent 409A valuation, apply additional illiquidity haircut (10-20%), consider staleness (how old is the 409A?), factor in company-specific risks, and arrive at advance rates of 30-50% of estimated value. That sounds conservative because it is conservative: startup equity is illiquid, volatile, and subject to restrictions that make liquidation unpredictable.

Transfer Restrictions: The ROFR Problem

Right of First Refusal

Almost all startup equity is subject to ROFR, meaning before any transfer (including to a lender via foreclosure), the company has the right to purchase the shares at the same price.

For lenders, this means you may need company consent to perfect a security interest, foreclosure may be blocked or delayed, and the company can effectively prevent liquidation by exercising ROFR. Some companies waive ROFR for pledges (but not sales), while others refuse. This needs to be determined before the loan closes rather than during a margin call.

Lock-Up Agreements

Post-IPO, employees typically face 90-180 day lock-ups during which they cannot sell regardless of what the market does.

For Lending: A loan secured by post-IPO shares in lock-up is a loan secured by illiquid collateral with volatile public pricing. The borrower can see the price dropping and can do nothing about it.

Trading Window Restrictions

Even after lock-up expires, insiders face quarterly trading windows, blackout periods around earnings, and pre-clearance requirements.

For Lending: Liquidation may be impossible on your preferred timeline, so build this into cure periods and margin thresholds.

Rule 144 Considerations

Sales of restricted and control securities must comply with Rule 144, including 6-month holding period for reporting issuers, volume limitations for affiliates, and manner of sale requirements.

For Lending: If the borrower is an affiliate (officer, director, significant shareholder), volume limits constrain how quickly you can liquidate.

What's Actually Pledgeable?

Generally Eligible: Vested, delivered common stock (subject to restrictions), post-exercise shares after holding periods expire, shares with ROFR waiver for pledges.

Generally Ineligible: Unvested RSUs (borrower doesn't own them), unexercised options (no asset exists), shares subject to litigation holds.

Advance Rates by Category:

Documentation Requirements

Before closing, obtain proof of ownership (stock certificate, book entry, option agreement), equity plan documents (the actual plan rather than summary), transfer restriction summary (what's the ROFR language?), company consent (if required for pledge), and most recent 409A valuation.

If the company won't acknowledge the pledge or waive ROFR for foreclosure, factor that into your advance rate and liquidation planning.

Setting Expectations

Be direct with borrowers about eligibility (not all their equity qualifies, unvested RSUs don't count), valuation (their back-of-envelope calculation using the last funding round price is higher than what you'll credit), advance rates (50% of a conservatively-valued illiquid asset means significant haircut from what they expected), margin risk (values can move, and margin calls may require additional collateral or paydown), and liquidation reality (if it comes to that, it won't be fast or clean).

The borrowers who understand these constraints upfront are better partners than those who discover them during a margin call.

The Employment Risk Problem

Startup equity is tied to employment, and employment is uncertain, creating risk that traditional collateral doesn't present.

If Jane gets laid off, unvested RSUs disappear, unexercised options may have a 90-day exercise window, and the collateral backing her loan may evaporate or diminish substantially. The loan obligation continues regardless, and this needs to be part of the conversation.

Why This Matters

Younger investors allocate 31% of their portfolios to alternatives versus 6% for older generations (Bank of America, 2022), and much of that alternative allocation is startup equity. The wealth is real, but the banking infrastructure to surface and lend against it doesn't exist in most institutions.

The institutions that figure this out, that build the valuation, custody, and margin infrastructure for startup equity, access a market that's currently underserved. The institutions that treat it like a minor extension of their public securities program are the ones that end up with problematic loan books.

Build the infrastructure first, then scale.

This article provides general information about startup equity lending considerations and does not constitute legal, tax, or financial advice. Borrowers should consult qualified professionals regarding their specific situations.