An ever-increasing number of shareholders of late-stage private companies are seeking liquidity, and with good reason. As companies stay private longer and longer, the lack of liquidity, and its converse, over concentration in a single stock becomes even more burdensome.
For the great majority, though, it is their first time selling private company shares, and the process can be quite daunting. Selling shareholders must: (1) Analyze limited information to value their shares; (2) Source and negotiate with multiple potential buyers; (3) Retain or have the legal expertise to comply with securities laws, document the transaction and conform to the issuer’s unique transfer protocols. Even where a seller has access to these resources, finding the time needed to manage these tasks is frequently a problem.
Here are some things selling shareholders might keep in mind when navigating these challenging waters.
The first decision to make is whether or not to retain a broker. As the founder of SharesPost, I acknowledge a certain bias when it comes to this question. That said, I believe most sellers are materially better off using a broker. Selling private company shares is a lot more like selling a house than it is selling public company stock through your online brokerage account. Few shareholders have the private market expertise, information, network or time to represent themselves effectively. Just as you expect a good real estate agent will more than offset their commission by getting you a better price for your house, a private market broker can make an even greater difference when it comes to optimizing your chances to close a sale for full value.
If you elect to work with a broker, the next question, of course, is which broker? Because the secondary market for late-stage, venture-backed private growth companies (what we are calling the “Private Technology Growth” asset class) is so new, it can be hard to tell the quality firms/platforms from the fly-by-night operations. First, ask potential brokers how many private company secondary transactions they have closed and in how many different companies’ shares. The more transactions closed and the more issuers they’ve worked with, the more likely they have the requisite expertise, resources and issuer relationships to provide real benefit.
Next understand where the broker expects to find buyers for your shares. If the answer you get is, “we have a number of deep relationships with buyers,” that’s usually code for “I know a handful of people who might be interested in these shares and if they won’t bid, I will start trying to find someone who will.” I believe sellers do much better when they are leveraging a platform connecting thousands of private market secondary buyers. Ideally, your broker will be able to immediately use the platform to identify investors who are already seeking to buy the shares you are seeking to sell.
Lastly, you should make sure that you are retaining a firm that is a FINRA registered broker-dealer that specializes in and is licensed to facilitate private market secondary transactions. This is different than an individual that hangs their license at a broker-dealer selling every financial product under the sun. You should also ask if they have their own in-house legal and compliance teams or if they just outsource those functions. If the former, you can count on a team to move the transaction along efficiently and without legal or regulatory problems. Finally, make sure to look up prospective brokers and their firms on FINRA’s BrokerCheck to confirm they don’t have any client complaints or compliance violations.
Whether or not you work with a broker, the first rule of private market sales is respect the company whose shares you are looking to sell. Most private companies are generally sympathetic to their shareholders liquidity needs, but they have several very valid concerns about what form that liquidity takes. Companies address these concerns by placing restrictions on secondary share sales. Understanding those restrictions avoids unnecessary conflict with the company and can save you a great deal of time. There’s no point spending weeks putting together a sale your company will never permit. This is another area where a good broker can help you. At SharesPost, for example, we have closed thousands of transactions in more than 150 of the leading private tech companies. As a result, we likely will already understand your issuer’s preferences for new shareholders (i.e., your buyer) and their transfer processes.
The next step is to come to a view of what your shares are worth. Unlike public company shares, there is no easy way to value private equity, but there are some useful benchmarks you should be aware of before having your first discussion with a potential buyer. The simplest and most reliable indicator of a company’s enterprise value is its most recent primary financing round. Also relevant might be any valuations disclosed by mutual funds that are already shareholders in the company. Selling shareholders must, however, be cognizant of the differences between classes of stock. Preferred stock comes with liquidation preferences and other benefits that make it more valuable than common stock. So-called “waterfall charts” must be used to translate between particular share classes and overall enterprise value. If you are working with a broker, they can provide you with, and walk you through, all of the research, information and valuation tools needed to get comfortable on pricing.
With a price in mind, you can now begin to negotiate with prospective purchasers. Engaging with multiple buyers simultaneously creates competition and makes it more likely that you end up with a buyer who closes. Connecting with too many buyers though, can unnecessarily drag the process out. Worse, many serious buyers will refuse to waste time participating in a cattle call. It may also make the company nervous about the amount of information that may be getting shared with a large number of market participants. At SharesPost, we typically will leverage our online platform to identify high-quality investors who have already indicated interest in the shares to be sold. We then execute non-disclosure agreements with a manageable number of them and begin a competitive but efficient process to ultimately select the best buyer and set price.
The terms of your sale are set forth in a Stock Purchase Agreement. That purchase agreement and a summary are sent to the issuer to notice the proposed transaction. Many issuers have their own unique process they require selling shareholders to follow. Many will want information about the proposed buyer to determine if he or she would be a desirable shareholder. Almost all shares are subject to a right-of-first-refusal under which the company or their assignee can “step into the shoes” of your buyer. Whether or not your buyer, the company or their assignee ends up purchasing your shares, your sale should close within 30-60 days of submitting the transaction to the company.
Compared to most securities transactions, selling private company shares can be a long, arduous process. The good news is that, over the last few years, such sales have nonetheless become commonplace and there are now experts and platforms to make the sale much easier. The even better new is that the market continues to improve – issuers, shareholders, investors and the platforms that connect them are becoming ever more integrated, more efficient.
Greg Brogger is Founder and CEO of SharesPost.