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Selling our shares pre-IPO

Lesson in Course: Finance at work (advanced, 4min)

My company is doing well and is planning to raise another round of financing. Do I need to wait for an IPO to sell?

Eureka!

What it's about: Liquidity events before a company goes public.

Why it's important: As companies stay private longer, these liquidity events offer rare chances to sell earlier.

Key takeaway: A Right of First Refusal limits who we can sell our shares to.

More investors are catching on to the incredible returns available in the private markets. There is increased interest in investing in a company before it's publicly listed, and there's a lot more money flowing into the venture capital ecosystem. As more money starts chasing startup investment opportunities, the supply and demand for startups change in the favor of employees.  Successful businesses are still difficult to come by and with new investors joining every day, options are becoming more limited for VCs to invest in. As a result, investors are starting to buy shares from employees before a company chooses to go public.

Pre-IPO liquidity events

In the scenario described above, a company can coordinate a tender event with existing or new investors.

What is Tender offer?

A tender offer is a company-sponsored liquidity event where current investors or new investors offer to buy shares from employees. 

Tenders are becoming increasingly popular as companies are staying private for longer. Enough investors want to continue buying into a successful company, that more money is being offered than what the company needs. In this case, the company allows investors to buy shares from employees.

Tender offers allow investors to buy shares from employees
Example of a tender offer

The offer

  • Investor A offers to buy at least 3,000,000 shares, or 5%, of StartupCo's common stock at $100 per share
  • The fair market value (FMV) of StartupCo's stock prior to the tender offer was $90 per share
  • The offer lasts for 20 business days

The limitation

  • As current employees, we can sell up to 10% of our shares while former employees can sell up to 50%

Almost all companies set restrictions on the amount of shares current employees can sell. Otherwise, tenured talent would take their full payday and move onto other companies.

 

Another way employees are finding liquidity before an IPO is by directly finding buyers for their shares through a secondary market. As an employee, we might be approached directly by another investor, without approval from the company, to purchase our shares. We also have the right to shop around and negotiate a fair price.

 

Secondary markets are growing for shares in hot startups

While there is nothing wrong with an employee securing a future for themselves, startups often prefer not to have outstanding shares sold to unauthorized investors. In the equity agreement, investors in startups will include a provision that restricts the sale of stock to an outsider or the Right of First Refusal.

What is Right of First Refusal ?

ROFRs protect the company and allow the board to control who can be an owner of the company by giving the company or existing investors the right to purchase shares directly from an employee.

Under a ROFR, the existing investors in the company have the right to make the first offer to purchase the shares directly from us.

ROFRs can block a potential sale to an outsider

We tend to get a better offer if we've been able to negotiate a price with an outside investor. Here's a quick video to add some more context around a ROFR.

What is a ROFR?

 

https://youtu.be/H0xUlQlpt1Y
 

Actionable ideas

Liquidity events are incredible for employees and investors when they happen. It's the first time that the market recognizes the years of hard work, blood, sweat, and tears in the form of a nice payday. As we plan to buy a new home or perhaps a sports car, it's important to pay attention to when companies may run liquidity events. Normally investors are eager to buy shares into a company because they believe there is more money to be made. If they are right, then it may make sense to not sell all of our shares during a tender offer or on the secondary market.

 

What's next

Financial planning for tech employees

Learn how Java Wealth Planning can help you with your equity compensation.

Get a free analysis!https://app.getmedes.com/courses/23/lessons/347

Supplementary materials

Examples of existing buyers in the secondary market.

PoorFounders - Before Life Doesn't Wait For Your IPO
Go to PoorFoundershttps://poorfounders.com/

Commercial banks like Manhattan Venture Partners also are very active in the pre-IPO space.

Manhattan Venture Partners - Manhattan Venture Partners

Manhattan Venture Partners is a research-driven merchant bank focused on the secondary market for late-stage, Pre-IPO companies.

Check out MVPhttps://mvp.vc/

Glossary

What is Right of First Refusal ?

ROFRs protect the company and allow the board to control who can be an owner of the company by giving the company the right to purchase shares directly from an employee at an already negotiated price.

What is Tender offer?

A company-sponsored liquidity event where current investors or new investors offer to buy shares from employees.