Latest / The Startup Exit Podcast with Fexingo: IPOs, Acquisitions, and Founder Liquidity Events / How Founders Use Put Options to Lock in Exit Price
Transcript
- Lucas: So there's this company called Arena — the AI leaderboard site that everyone in machine learning uses to compare models. It just got acquired for about 100 million dollars, and the founders reportedly used a put option structure to lock in a floor price months before the deal closed. Luna: Wait — a put option on a private company? I thought puts were a public-market thing. How does that even work when there's no ticker? Lucas: Yeah, that's the thing — it's a bespoke contract, usually structured through an investment bank or a specialist firm. The founder essentially buys a put from a counterparty — like a hedge fund or a bank — that guarantees they can sell their shares at a certain strike price on a future date, regardless of what the actual exit valuation ends up being. Luna: So it's insurance. You pay a premium, and if the deal falls short, the counterparty makes you whole up to the strike. Lucas: Exactly. In Arena's case, the founders reportedly paid a premium equal to about 3 percent of the notional value — so on a 100 million dollar position, that's 3 million dollars in premium. In exchange, they guaranteed they'd get at least 90 cents on the dollar, even if the sale price cratered. Luna: Three million bucks is a lot of money. If you're a founder who thinks your company is going to pop, why not just ride it out and save the premium? Lucas: That's a fair question, and a lot of founders do exactly that. But remember — by the time you're negotiating an exit, you've often got a lot of concentrated wealth tied up in one stock. If the market turns, or the deal falls through, or the acquirer's stock drops, you could lose years of value. The put gives you sleep-at-night certainty. Luna: But doesn't that cap your upside? If the acquisition price comes in at 120 million instead of 100, you're still locked in at the strike, minus the premium. Lucas: Right — it's a trade-off. You're trading upside for downside protection. But some founders structure it so the put only covers a portion of their shares — say 50 percent — so they still have upside exposure on the rest. Others use a collar: buy a put, sell a call, and the premium from the call offsets the put cost. That way you cap both sides but net zero premium. Luna: And who's on the other side of these contracts? If I'm a hedge fund writing a put on a private company, I'm taking on a lot of risk — I don't really know the true value. Lucas: You're right — it's not like writing a put on Apple or Microsoft where there's liquid options markets and daily price discovery. The counterparty does deep diligence: they look at the company's financials, recent funding rounds, comparable exits, even talk to potential acquirers. And they charge a higher premium to compensate for the illiquidity. Typically you're looking at 2 to 5 percent of notional for a one-year put on a late-stage private company. Luna: So it's expensive. But I guess if you're sitting on 50 million dollars in paper value, paying a million or two for certainty might be worth it. Lucas: And the market for these instruments has grown a lot in the last 18 months. I was looking at some data from a derivatives boutique — they said the notional value of private-company puts written in the first half of 2026 was up about 40 percent year-over-year. A lot of that is driven by founders who saw what happened in 2022 when valuations got cut in half and IPO windows slammed shut. Luna: That makes sense. If you lived through that, you'd want some protection. But what about the mechanics at the actual exit? If the company goes public, the put converts into a put on the listed stock, right? Lucas: Typically, yes. The contract will specify a conversion mechanism. If there's an IPO, the put usually converts into a publicly traded put option on the new ticker, with adjustments for the IPO price. If it's an acquisition for stock — say the acquirer pays in shares — the put might convert into a put on the acquirer's stock. And if it's an all-cash deal, the put just settles in cash. Luna: So the counterparty is on the hook for the difference between the strike and the actual sale price. That's a big liability if the company goes under. Lucas: That's why the counterparty usually requires collateral — often a pledge of the founder's shares. So if the company goes to zero, the counterparty gets the shares and the founder gets the strike price. It's essentially a secured loan structure, but structured as a derivative for tax and legal reasons. Luna: Speaking of tax — how does the IRS treat the premium? Is it deductible? Lucas: That's a tricky area. Generally, if the put is tied to the founder's shares, the premium is treated as a cost of the shares — it adjusts the cost basis. So it's not deductible as an ordinary business expense. But if the company itself buys the put — say as part of a stock repurchase program — it could be treated differently. Founders should definitely talk to a tax advisor before doing this. Luna: Right. Let's talk about a concrete example. Say a founder has 10 million shares in a company that's about to IPO. The expected IPO price is 20 dollars, so the stake is worth 200 million. They want to protect against a drop to 15. How does the put work? Lucas: Okay, so they'd go to a bank and say: I want a put option with a strike of 15 dollars, expiring maybe 6 months after the IPO. The bank will price that based on the expected volatility of the stock after listing. For a typical tech IPO, implied volatility might be 40 to 60 percent. On a 200 million dollar notional, a 6-month put at 15 dollars — that's 25 percent out of the money — might cost around 2 to 3 percent of notional, so 4 to 6 million dollars. Luna: That's a big check to write. But if the stock drops to 10, the put pays out 5 dollars per share — 50 million dollars — minus the premium. So net floor is around 13.50 or so. Lucas: Exactly. And if the stock goes to 30, the founder just lets the put expire worthless. They're out the premium, but their shares are worth 300 million. So it's a tail hedge, not a full guarantee. Luna: I've heard that some founders are now putting these puts in place even before the S-1 filing, sometimes a year or more before the expected IPO. Is that becoming common? Lucas: It is. Especially in sectors like biotech and AI, where the timeline to exit is uncertain and the market can shift quickly. If you look at the Ark Innovation ETFs — ARKK is up about 5 percent this week, but its 5-day move is volatile. Founders in those high-growth spaces are more likely to hedge early because they've seen the drawdowns. Luna: And what about the Arena founders specifically? Do we know how they structured it? Lucas: Details are sparse because it's a private transaction, but from what has leaked, they used a put spread — buying a put at a higher strike and selling a put at a lower strike to reduce the premium cost. So they capped both the upside and the downside. It's a common structure for founders who want cheap protection but are willing to accept a floor that's lower than a straight put. Luna: So they got a floor at, say, 80 million instead of 90, but the premium was maybe 1 percent instead of 3. Lucas: Exactly. And that's the art of it — you can tailor the strike, the tenor, the structure, the percentage of shares hedged. It's not a one-size-fits-all product. And it's worth noting that the put market for private companies is still relatively small — maybe 5 to 10 billion in notional globally — but growing fast. Luna: I wonder if this will become standard practice, like how every public company CEO has a 10b5-1 plan. Maybe in a few years, every Series A term sheet includes a discussion of hedging strategy. Lucas: That's an interesting thought. For now, it's still something only sophisticated founders with large stakes tend to use. But as the ecosystem matures and more liquidity events happen through SPACs, direct listings, and acquisitions, I think we'll see more founders using derivatives to manage their concentration risk. Luna: If these conversations are useful for what you're building or running, consider supporting the show. It keeps us independent and ad-free. You can find us at buy me a coffee dot com slash fexingo. Lucas: Yeah, listener support makes a real difference — lets us keep drilling into these niche topics without worrying about sponsors. And we appreciate every bit of it. Luna: So back to puts — one question I've had: what happens if the IPO doesn't happen at all? The put expires, the founder loses the premium, and they're back to square one. Lucas: That's the risk. If the company stays private, the put is typically cash-settled based on a valuation determined by a mutually agreed-upon process — like an appraisal or a subsequent funding round. But if the company just keeps operating and never has a liquidity event, the put might be extended or settled at a loss. That's why these contracts usually have a defined term — one to two years — and are meant to cover a specific exit window. Luna: So it's not a permanent solution. It's a bridge to an exit. Lucas: Exactly. And that's why founders should think about it as part of a broader liquidity plan — along with tender offers, secondary sales, and structured payouts. The put is one tool in the kit, not the whole toolbox. Luna: Alright, final question for you: if you were a founder today, with a late-stage startup valued at 500 million, would you buy a put? Lucas: I think I would, but only on a portion of my shares — maybe 20 to 30 percent. Enough to cover my downside if the market turns, but not so much that I'm giving up all the upside. And I'd use a collar to keep the premium low. But honestly, it depends on the sector, the volatility, and my personal risk tolerance. Every founder's situation is different. Luna: Good answer. And with that, thanks for listening. We'll be back next week with another deep dive into founder liquidity.