An ever-increasing number of shareholders of late-stage private companies are seeking liquidity, and with good reason. As companies stay private longer, the lack of liquidity, and its converse, over-concentration in a single stock, becomes even more burdensome. Even in the bullish cases where shareholders see an IPO on the horizon, they may prefer to take some money off the table today rather than further delay and rely entirely on the uncertainty of a public market’s treatment of the stock price over the 180 day lock up period during which they cannot typically sell their shares.
For the great majority of shareholders seeking to sell private stock for the first time, the process can be daunting. Selling shareholders must: (1) analyze limited information to value their shares; (2) source and negotiate with multiple potential buyers; and (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 a frequent problem.
Here are some points selling shareholders might keep in mind while 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 online. Few shareholders have the private market expertise, information, network or time to effectively represent themselves. 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 decide to work with a broker, the next question is which broker? Because the secondary market for private growth companies is relatively new, it can be hard to tell which firms are able to add real value. To help determine this, first, find out how long candidate firms have been operating a private secondary market. Then I recommend asking asking how many private company secondary transactions they have closed and in how many different companies’ shares. The longer they have been in business, the more transactions they’ve closed and the more issuers they’ve worked with, the more likely they are to have the requisite expertise, resources and issuer relationships to successfully complete your sale.
Next you need to understand where the broker expects to find buyers for your shares. Ideally, the firm has previously transacted in your company’s shares. If they haven’t or if they’re vague about the buyers they have in mind for your shares, they may spend months trying to source buyers from a cold start. I believe sellers generally do much better when they leverage an active marketplace that continually connects sellers with many interested buyers. At SharesPost for example, we use proprietary trading systems to select buyers for our clients from a network of more than 50,000 accredited investors and institutions.
Lastly, you should make sure your broker-dealer is registered with the Financial Industry Regulation Authority (FINRA) and is specifically licensed to facilitate private market secondary transactions. This is different than a broker that merely “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 outsource those functions. If the former, you can count on the expertise to move the transaction along efficiently and without legal or regulatory issues. Finally, look up prospective brokers and their firms on FINRA’s BrokerCheck to confirm they don’t have a history of client complaints or compliance violations.
Whether or not you work with a broker, the first rule of private market transactions is: respect the company whose shares you are looking to sell. Most private companies are generally sympathetic to their shareholders’ need for liquidity. But they have very valid concerns about what form that liquidity takes and thus place 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 on a sale the company will never permit. This is another area where a good broker can help you. At SharesPost, our Private Securities Specialists have closed thousands of transactions in more than 250 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 figure out the value of your shares. Unlike public company shares, there is no easy way to value private stock , 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, recognize the differences between classes of stock. Preferred stock comes with liquidation preferences and other rights 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 should be able to provide you with, and walk you through, all of the research, information and valuation tools needed to get comfortable on valuation.
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 refuse to spend time participating in cattle calls. It may also make the company nervous about the company information being 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 potential buyers and begin a competitive but efficient process to select the best buyer and set price.
A stock purchase agreement sets forth the terms of your sale. The issuer receives a copy of that agreement and a summary of the proposed transaction. Many issuers have a unique transfer process selling shareholders must follow. They also frequently want information about proposed buyers to determine their desirability as a shareholder. Finally, almost all shares are subject to a right-of-first-refusal (ROFR), which enables the issuer to replace your buyer. Whether or not the company exercises its ROFR, your sale should usually close within 30-60 days of submitting the transaction to the company.
Compared to most securities transactions, selling private company shares can be a challenging process. The good news is that, over the last few years, such sales have become commonplace and there are now marketplaces to easily facilitate these transactions. The even better news is that the market continues to improve – issuers, shareholders, investors and the platforms that connect them are becoming ever more integrated, more efficient, which leads to less friction and ease of execution.
Greg Brogger is Founder and CEO of SharesPost, the leading private securities marketplace.
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