Cashing Out Startup Shares: Calculating Potential Value and Costs
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:
- Private buyers may ask for the company’s internal financials in order to estimate the current and future value of its stock; the company may not wish to share this confidential information.
- Companies must consider whether sales could influence their 409A valuation.
- Secondary sales are an administrative and legal burden that may not make it to the top of the list of priorities for busy startup CEOs and CFOs, particularly at smaller startups.
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:
- EquityZen: Investors are typically looking for investments in later stage technology companies with a profile of over $50M in VC funding from top quartile firms, Series C or later, with the objective of finding investments that may exit in the next 2-5 years.
- Forge: Investors are typically looking for investments in later stage companies (typically Series E or later, $2 billion valuation or higher), or mid-stage companies (typically Series B through Series D, $200 million – $1 billion valuation).
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 transactions are more infrequent, 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.
- Their fees are calculated as a % of the value of your shares after your company IPOs, is acquired, or your shares are otherwise liquidated; no out of pocket upfront fees.
- Typically a 3:1 shares to lien value and a PIK interest rate as well as additional fees. The employee needs to own enough equity to qualify for the minimum loan amount.
- Financing is non-recourse financing against the underlying shares for cash to exercise options or for liquidity in general.
- Using financing in general is the only way to obtain liquidity without giving up all future upside. Unlike recourse financing (e.g., personal loans) that can be obtained at a bank, non-recourse does not require personal liability and prevents other unrelated assets from being collateral (e.g., your home, car, etc.). Non-recourse financing is the only option to obtain liquidity without giving up all future upside on a shareholder’s equity.
- These platforms typically look for holdings in late stage companies and only offer loans to a select number of companies.
- For more information on specific minimums, requirements, etc., please reach out directly to the vendors:
- Another alternative option is bulge bracket lending via consumer banks. They offer recourse debt financing that provides liquidity but requires the borrower to have personal liability.
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.
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.
- Advice on Startup Liquidity Mistakes from AJ Wealth
- Harness Wealth’s Promissory Note Program: A Financial Employee Benefit for Early-Stage Startups
- Diversify Your Portfolio: How Startup Employees Over-invest in Tech