By Harness WealthFinances — April 29, 2020

Cashing Out Startup Shares: Calculating Potential Value and Costs

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Will your startup allow you to sell your shares?

Private sales generally require the agreement and cooperation of the startup, for both contractual and practical reasons. About half of startups will allow you to sell, and there are now some non-traditional forward contract options if your company does not allow a traditional sale.

Typical objections/concerns from a company include:

Image adapted from Stanford Closer Look Series: Private-company Exchanges and Employee Stock Sales Prior to IPO

Are your shares in demand?

What is the viability of you selling your shares? As a general rule of thumb, the later the company and closer to IPO, the more likely investors are to be interested, and venture-backed US technology companies typically have more demand.

Two examples from specific platforms:

How much will you make, and how much will it cost (stock option exercise cost, taxes, and fees)?

When calculating the potential cash value to a shareholder, remember to net out transaction fees and tax liabilities: You can use the Harness Wealth Downloadable Private Shares Cash Flow Calculator to roughly plan for the amount of cash that will go in and out as part of your exercising of the shares and the subsequent sale. Download or make a copy of this Google sheet to run a few different scenarios for yourself, based on the amount of shares, exercise and sale dates, and value of the shares.

The valuation on secondary marketplaces relies on market pricing established by investors and shareholders, and your shares will likely be priced at a an approximately 10 to 50% discount vs the valuation from a recent financing round.

As a baseline, employee equity typically sells at a discount to financing round valuations because institutional investors are issued preferred stock, which is more senior and therefore more valuable on the equity stack than an employee’s common stock. The steepness of the discount is uniquely determined on a company-by-company basis and is a function of factors such as general market conditions, the company’s performance, and proximity to a potential liquidity event. A company with strong performance and close to an IPO will likely be valued at lower discounts.

A quick tax note: Plan ahead of time when options and restricted stock are issued or exercised to minimize potential future tax bills by utilizing the Section 83(B) election.

What is the process? How long will it take?

The first step is to gather and confirm investor interest

Do not act upon exercising for the purposes of selling without ensuring that there are viable buyers for your shares. Depending on the company, this can take just days for commonly transacted companies or several weeks for companies where we have infrequent transactions, or when there happens to be a dip in investor interest in the company.

Do you have enough cash on hand to exercise your stock options (ISOs, NSOs)?

Once you’ve decided that you would like to exercise, you will have to have enough cash on hand (see calculator above) to go through the exercise process with your company.

What are some financing options?

If you do not have enough cash to exercise, there are some that platforms offer financing to provide liquidity to shareholders of private companies against their private stock holdings. This liquidity can be used to exercise options, pay taxes on exercised options, diversify concentrated stock positions, or make a large purchase (house, car, etc.).

If the liquidity platforms are used to exercise options independent of a potential shares sale, the shareholder can hold onto the potential upside of their shares in the future and potentially receive tax advantaged treatment at the time of sale by qualifying for long-term capital gains.

Selling your shares

Selling Your Startup Shares: Comparison of Secondary Stock Marketplaces compares and contrasts the various fees, minimums, and other considerations as you decide which vendor/vehicle to go with.

Timing

After a buyer is found and terms are confirmed, the process usually takes 6-8 weeks, including going through the ROFR (Right of first refusal) process and getting the company’s decision on that.

For the liquidity platforms where the shareholder borrows against his or her stock, the process can take as little as 24 hours, but typically takes 1-3 weeks when there is not an urgent time constraint.

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