Selling Private Company Stock: The Insider's Guide To Cashing In Before The IPO
Startups can be exciting and promising ventures, but they often require significant time, effort, and money before becoming profitable. As a result, many startup employees are given the opportunity to invest in the company's future by receiving stock options or restricted stock units (RSUs) as part of their compensation package.
However, selling these shares can take time and effort until a company goes public. Let’s discuss how startup employees can sell shares of their privately held stock before it goes public and some of the challenges they may encounter along the way.
UNDERSTANDING PRIVATE COMPANY STOCK
Stock in a private company refers to shares of ownership in a company that is not publicly traded. This means the company is not listed on a stock exchange, and shares cannot be bought or sold on the open market.
In other words, the company is "pre-IPO". Instead, shares of private company stock are typically held by the company's founders, employees, and investors.
BENEFITS OF PRIVATE COMPANY STOCK
There are several benefits to holding stock in a private company—particularly for startup employees who are granted stock options or restricted stock units as part of their compensation package. Some of the benefits of private company stock include:
Potential for significant returns: Private company shares can often offer significant returns if the company is successful and its value increases over time. For startup employees, this can be an important part of their overall compensation package.
Alignment with company goals: Employees are more aligned with the company's long-term goals and performance by holding private company stock. This can incentivize employees to work harder and contribute more to the company's success.
Diversification of investments: Private company stock can be a way to diversify one's investment portfolio, particularly if the employee already has significant holdings in publicly traded stocks or other investments.
Potentially favorable tax treatment: Depending on the circumstances, selling private company stock may result in more favorable tax treatment than selling publicly traded stock.
Opportunities for liquidity: While private company stock is generally illiquid, there are opportunities for employees to sell their shares on the secondary market or to other investors. This can give employees some liquidity, even before the company goes public.
Overall, holding private company stock can be a valuable part of an employee's compensation package, particularly for those working in startups or other high-growth companies. However, it's important for employees to understand the risks and potential challenges of holding private company stock and the opportunities for selling their shares when the time is right.
RISKS AND CONSIDERATIONS
Selling private company stock before a company goes public comes with several risks and considerations. For one, finding potential buyers can be challenging, and there is no guarantee that the shares will sell at the desired price.
Additionally, the fair market value of private company stock can be difficult to determine, and there’s no guarantee that the company will be successful in the long run. Selling private stock can also have tax implications, so it's essential to consult with a tax professional before making any transactions.
STOCK OPTIONS AND RSUS
One common form of equity compensation for startups looking to incentivise new hires along with their current employees is stock options, which give employees the right to purchase company stock at a fixed price (known as the exercise price) at a later date.
This allows employees to potentially benefit from the company's growth and success.
Restricted stock units (RSUs) are another form of equity compensation that can be offered by startups. RSUs grant employees the right to receive shares of the company's stock once certain conditions are met, typically vesting over a period of time.
RSUs are often seen as more straightforward than stock options because there is no exercise price to worry about. Instead, the shares are simply granted to the employee once they have vested.
PRE-IPO SECONDARY MARKET
One option for startup employees looking to sell their private company stock is to use the pre-IPO secondary market. This market allows investors to buy and sell shares of private stock before the company goes public.
By selling their shares in the pre-IPO secondary market, employees can potentially realize some of the value of their equity compensation before the company goes public.
Several online platforms, such as SharesPost and EquityZen, connect buyers and sellers of private company stock. These platforms typically have a network of accredited investors who are interested in purchasing private company stock. Accredited investors are individuals or entities that meet certain financial criteria, such as having a net worth of at least $1 million or an annual income of at least $200,000.
However, there are typically restrictions on who can buy and sell shares in the pre-IPO secondary market. For example, many platforms require investors to be accredited and may also restrict how much stock can be bought or sold at a time.
Overall, the pre-IPO secondary market can be a useful tool for startup employees looking to sell their private company stock, but it's important to carefully consider the risks and restrictions involved. Working with a financial advisor or using a reputable online platform can help employees navigate this process.
NETWORKING WITH PRIVATE INVESTORS
For startup employees looking to sell private company stock, networking with private investors can be another option.
Private investors—such as venture capitalists and angel investors—may be interested in buying shares of a promising startup before it goes public. Employees can potentially find a buyer for their private company stock by connecting with these investors.
However, networking with private investors can be challenging, as it requires building relationships and making connections in the industry—not an overnight process! One way to start is by attending industry events and conferences, which can provide opportunities to meet potential investors and learn more about their interests and investment criteria. Social media and online networking platforms can also be useful tools for connecting with investors.
When networking with private investors, it's important to clearly understand the value of the private company stock being sold. This may require obtaining a professional valuation of the company, which can help both the employee and the investor to determine a fair price for the stock.
It's also important to carefully consider the potential risks and rewards of selling private company stock to private investors. While this can be a way to realize some of the value of equity compensation, it can also give up potential future gains if the company goes public or is acquired at a higher valuation.
Careful research and preparation can help employees navigate this process and find the right share buyer.
WORKING WITH A BROKER OR INVESTMENT BANK
In addition to the pre-IPO secondary market and networking with private investors, startup employees can also work with a broker or investment bank to sell their private company stock. These professionals can help employees find potential buyers and navigate the often-overwhelming legal and financial aspects of the transaction.
However, choosing a broker or investment bank with experience selling private stock is important. The process of selling private company stock can be complex, and inexperienced brokers or banks may be unable to provide the necessary expertise and support. Look for a broker or bank with a strong track record in selling private stock and a good reputation in the industry.
It's also important to clearly understand the fees and commissions involved. These can vary widely depending on the broker or bank, the complexity of the transaction, and other factors. Be sure to ask for a clear explanation of all fees and commissions, and consider negotiating for lower fees if possible.
In addition to helping sell private company stock, brokers and investment banks can also provide advice and guidance on other aspects of equity compensation, such as stock options and RSUs. This can be especially valuable for employees new to the startup world and unfamiliar with these types of equity compensation.
By choosing a reputable and experienced professional, employees can ensure that they receive the support and expertise they need to navigate this complex process.
VALUING PRIVATE COMPANY STOCK
Before attempting to sell private company stock, it's essential to determine its fair market value. This can be challenging, as there is no established market for private company stock.
Valuation methods may include discounted cash flow analysis, comparable company analysis, and option pricing models. Working with a professional valuator can be helpful in this process—we highly recommend it!
RESTRICTIONS ON SELLING PRIVATE COMPANY STOCK
Startup employees should also be aware of any restrictions on selling private company stock. These restrictions may be outlined in the employee's stock option or RSU agreement and may limit the employee's ability to sell shares before certain conditions are met.
Additionally, if the company has taken on venture capital or other forms of investment, there may be restrictions on selling shares to prevent dilution of the company's ownership structure.
NEGOTIATING THE SALE OF PRIVATE COMPANY STOCK
When selling private company stock, it's important to negotiate the terms of the sale carefully. This may include determining the purchase price, the number of shares sold, and any restrictions or contingencies on the sale. Working with a lawyer or other professional can help ensure the transaction is legal and fair.
PROTECTING CONFIDENTIAL INFORMATION
Finally, startup employees must protect confidential information when selling private company stock.
This may include ensuring that potential buyers sign non-disclosure agreements and being careful about what information is shared during the negotiation process. The company may also have policies regarding the sale of private company stock, and it's essential to follow these policies to avoid legal issues.
FINAL THOUGHTS
Selling private company stock can be challenging but integral to many startup employees' compensation packages.
By understanding the options available for selling private company stock and working with experienced professionals, startup employees can benefit from the value of their shares even before the company goes public.
Need some help understanding your stock options? Let’s connect!
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