Equity compensation is a popular strategy used by startups to attract and retain top talent, and it can sometimes result in significant financial rewards for founders and employees alike. However, realizing the value of equity can be rare, particularly when the company has no immediate plans to go public. Tender offers are one such strategy that provide a solution for employees to unlock the value of their equity without waiting for an Initial Public Offering (IPO) or acquisition. In this guide, we’ll explore the ins and outs of tender offers, discuss their associated tax implications, and give you the information you need to plan ahead for any tender offers in your future.
Table of Contents:
- What Is A Tender Offer?
- How Does A Tender Offer Work?
- Do You Owe Taxes In A Tender Offer?
- Pros and Cons of Tender Offers for Startup Employees
- Personal Financial Planning Considerations
- Frequently Asked Questions
What is a Tender Offer?
A tender offer is a liquidity event in which a company, investor, or group of investors propose to buy a fixed number of shares from existing shareholders at a set price. Tender offers can be made for both private companies and public companies, with recent examples of both being Stripe and Twitter, respectively.
It is important to understand the differences between tender offers and IPOs. Both are liquidity events, but an IPO (Initial Public Offering) involves a company’s first listing on a stock exchange like the New York Stock Exchange or Nasdaq. A tender offer, on the other hand, is not a public event and doesn’t guarantee that a company will eventually go public.
How Does A Tender Offer Work?
Tender offers can be initiated for various reasons, from takeover bids (i.e., Twitter) to fundraising events (i.e., Stripe). Once the terms are agreed upon, it’s the company’s responsibility to notify shareholders and employees about the upcoming liquidity event and provide them with the offer’s terms so that they can plan ahead. Tender offers, such as in the case of Stripe, are not always large enough to buy every share of the company, and in such cases, there might be restrictions on which employees or types of equity are eligible to participate in the sale.
In the case of Stripe, for their 2023 tender offer, the payment processing company used the money raised to provide liquidity to many of its early employees holding double-trigger RSUs that were set to expire after 10 years in 2024. By arranging a tender offer, Stripe was able to facilitate both a liquidity event for its earliest employees, and cover the associated taxes in the process.
For employees ineligible for a tender offer or those who prefer to sell their shares on their terms, secondary sales may present a viable alternative option. Secondary sales represent a different type of liquidity event in which existing shareholders sell their shares directly to private investors or through an online pre-IPO startup equity marketplace. Secondary sales are growing in popularity and can allow employees more freedom in when and how they sell their shares, but often still require final approval from their employer.
Do You Owe Taxes In A Tender Offer?
A tender offer is an organized sale of company shares, and the taxes owed depend on a number of factors including the types of shares you have, how long you’ve held them, and if you’ve made any tax election you’ve made such as an 83(b) Election.
Restricted Stock Units (RSUs) and Non-Qualified Stock Options (NSOs), for example, will be subject to both ordinary income tax when they vest, and capital gains tax when they are sold. Because of this, timing the sale to align with a tender offer can provide you the liquidity needed to cover both the ordinary income tax and the capital gains taxes all at once, which can be highly beneficial depending on your cash on hand. Keep in mind that NSOs will need to be exercised before they can be sold in a tender offer.
Incentive Stock Options (ISOs), on the other hand, are only subject to capital gains tax, and taxes are only owed when shares are sold, though depending on the size of the sale, exercising ISOs can result in Alternative Minimum Tax (AMT).
Pros and Cons of Tender Offers for Startup Employees
Participating in a tender offer is a major financial consideration, and you should consult your Harness Tax Advisor or other tax professional before making any final decisions. Here are some positive and negative considerations to keep in mind:
Pros:
- Access to liquidity: Tender offers provide employees an opportunity to sell their shares and access cash before an IPO or other liquidity event.
- Premium pricing: Tender offers can sometimes come with a premium price tag applied to the current fair market value of the equity being purchased, allowing employees to realize a nice bonus on their shares.
Cons:
- Discounted pricing: Just as tender offers can sometimes be priced at a premium, they can also sometimes be priced at a discount. By regularly monitoring the fair market value of your shares and the 409A valuation of your company, you’ll be quick to know how fair of a deal you’re getting.
- Limited participation: Tender offers may not be open to all employees, and those who are eligible might be restricted in the number of shares they can sell.
- Tax implications: Participating in a tender offer will lead to tax liabilities, which should be carefully assessed before deciding to participate.
- Missing out on future growth: By selling shares in a tender offer, employees could miss out on potential future growth or other liquidity events such as an IPO, depending on how many shares they hold onto after the fact.
Personal Financial Planning Considerations
No matter the amount of cash you end up with after a tender offer or other liquidity event, thoughtful personal financial planning should always be considered as your immediate next step. Here are some general strategies to consider:
- Pay any taxes owed from the tender offer: Prioritize paying off any tax liabilities arising from the tender offer. Selling your shares will come with tax consequences, and you need to be prepared for that.
- Consider any short-term cash requirements or debt payments: Evaluate your current financial situation and use any proceeds to pay off high-interest debt or meet any pressing financial needs. This may include creating an emergency fund, paying off credit card debt, or addressing any outstanding loans.
- Explore tax-advantaged ways to invest for the future: Make use of tax-advantaged accounts such as IRAs, 401(k)s, or savings plans to invest the proceeds from the tender offer.
- Maximize your idle cash: Put your idle cash to work by placing it in high-yield savings accounts, money market accounts, or short-term investment vehicles that offer higher interest rates than traditional savings accounts.
- Exercise more options: Depending on the structure of your equity compensation, the proceeds from a tender offer may provide enough cash for you to justify exercising more options awarded to you by your employer. Reinvesting your money could be a worthwhile strategy depending on the future outlook of the company.
Frequently Asked Questions
- How do I know if my company is conducting a tender offer? Your company will notify you about the tender offer, outlining the terms, the price per share, and the number of days you have to participate. Tender offer periods typically last for at least 30 days.
- How many shares should I sell in a tender offer? The decision of how many shares to sell in a tender offer depends on your personal financial situation, goals, and risk tolerance. Consult with a Harness Wealth advisor or other financial planning professional to help you make an informed decision based on your individual circumstances.
- What happens if the tender offer is oversubscribed? If more shares are offered for sale than the buyer is seeking to purchase, the tender offer may be oversubscribed. In this case, the company or the buyer may choose to increase the number of shares they are willing to buy or allocate shares proportionally among the sellers. This may result in employees being able to sell only a portion of their shares, depending on the level of oversubscription and the allocation method chosen.
- Can I change my mind after accepting a tender offer? Generally, once you have accepted a tender offer and submitted your shares for sale, you cannot change your mind or withdraw your shares. However, the exact terms and conditions of each tender offer may vary, so it is important to carefully review the documentation provided by your company before making a decision.
- What happens to my shares if I don’t participate in the tender offer? If you choose not to participate in a tender offer, your shares will remain in your possession. But it’s important to be aware of any expiration dates on your options or RSUs, as some tender offers are timed accordingly to offer liquidity on expiring shares.
How Harness Wealth Can Help
Tender offers can provide startup employees with a tremendous opportunity to unlock the value of their equity compensation. However, participating in a tender offer is not without its potential drawbacks, such as tax implications, and the risk of missing out on future growth. As a startup employee, it is essential to evaluate your personal financial situation, goals, and risk tolerance, and consult with your Harness Tax Advisor or other tax professional and financial advisor before making any decisions related to tender offers or other liquidity events.
If you have equity compensation and have questions about how a tender offer might impact your financial goals and needs, consider booking an Equity Tax Planning Session with Harness Wealth. Our equity-experienced tax advisors will answer any question about your equity, and provide projections around potential equity decisions to help you make an informed decision for your financial future.
Tax services provided through Harness Tax LLC. Harness Tax LLC is affiliated with Harness Wealth Advisers LLC, collectively referred to as “Harness Wealth”. Harness Wealth Advisers LLC is an internet investment adviser registered with the Securities and Exchange Commission (“SEC”). Harness Wealth Advisers LLC solely acts as a paid promoter for unaffiliated registered investment advisers. Harness Wealth Advisers LLC’s registration as an investment adviser with the SEC does not imply a certain level of skill or training.
This document does not constitute advice or a recommendation or offer to sell or a solicitation to deal in any security or financial product. It is provided for information purposes only. To the extent that the reader has any questions regarding the applicability of any specific issue discussed above to their specific portfolio or situation, the reader is encouraged to consult with the professional advisor of their choosing. All investments have risks and have the potential for profit or loss.
