Pre-IPO Secondary Market: Liquidating Before Going Public

Contents

IPO

DEFINITION

The pre-IPO secondary market is the opportunities stockholders have to liquify their equity in a private company. In contrast with a primary market where companies sell shares, secondary markets, by definition, involve shareholders selling their shares to others.  

 

The Pre-IPO secondary market has been growing by the year, in part because more companies have been putting off going public. 

In 2019, startup powerhouses Uber, Slack, Pinterest, and a handful of others officially went public. AirBnB did not, frustrating many of its 6,000 employees looking to capitalize on their equity.

According to a study cited by McKinsey & Company, technology companies are, on average, staying private much longer than ever before. What has caused this trend? Major upticks in investments and revenue, resulting in businesses possessing the financial means to put off IPOs.

In fact, the fabled unicorns and decacorns (companies with $10 billion+ valuation) are now becoming more akin to a mustang horse. Rare, but not fantastical. 

This article will cover the available opportunities to liquify or buy shares on the Pre-IPO secondary market.

Why you might be interested in the Secondary Market

As companies continue to hold off IPO, more and more stockholders (especially employees like yourself perhaps) will look to liquify their equity in a private company, so they have immediate cash. Perhaps you want to move onto the next professional challenge, invest in a house, diversify your portfolio, etc. Additionally your stock options generally expire after 10 years, leaving early employees with nothing if the company doesn’t go public.   

Investors use the secondary market as an opportunity to acquire equity before it is offered publicly. Getting in pre-IPO often reduces costs for investors, although it presents some dangers (more on that later). 

Liquidity Solutions for Pre-IPO Secondary Market

You should know beforehand that transactions in the pre-IPO secondary market will pose difficulties you will not experience in the public market. 

With that disclaimer out of the way, let’s move on to four liquidity solutions you can pursue:  

  1. Private buyers 
  2. Brokers
  3. Share repurchases
  4. Secondary stock sales 

1. Finding private buyers

Unlike the public market that makes transactions convenient by matching buyers with sellers, the pre-IPO secondary market doesn’t have that system in place. This means sellers and buyers have to seek out one another, potentially incurring hefty costs for both parties. 

For sellers, the first major hurdle is finding an accredited investor (generally, a person with a net worth of $1 million +). That’s probably not an email or telephone call away, unless you have built some impressive connections. Furthermore, we’re just talking about tracking down people who qualify as accredited investors. Actually convincing them to purchase your equity will likely present its own set of challenges. 

The second major hurdle is the restrictions pre-IPO businesses often place on employee stock sales. Contractual obligations may prevent you from selling your shares without the approval of the company. Financial firms have assisted shareholders who wanted to sell by offering a loophole (e.g. the shares are collateral for a loan).  

For buyers, a risk of purchasing private shares is that they are not registered with the US Securities and Exchange (SEC). The lack of security/verification means you cannot ever be certain the seller actually owns the private shares.

Private companies have no obligation to disclose their financial statements and material information. They also run the risk of a fraudulent ‘buyer’ simply interested in checking out the inner workings of the business. Non-disclosure agreements (NDAs) enable buyers to gather details to help inform their purchase.  

Main takeaways from the buyer and seller’s perspectives:

SellersBuyers
  • Time and cost involved in finding an accredited investor
  • Restrictions on employee stock sales
  • Opportunities to circumvent contractual terms
  • Must be an accredited investor
  • Absence of SEC verification
  • Limited access to private company financials 

2. Going through a brokers

In response to the liquidity problem and lack of a buyer-seller ‘matching’ system, some financial firms have developed a solution for the pre-IPO secondary market. SharesPost (merging with Forge Global), for example, connects buyers and sellers, making sure their transactions abide by all SEC regulations. Using a broker can simplify, accelerate, and ‘legitimize’ the process, while reducing the legwork for both sides. 

This likely sounds ideal. There’s always a ‘but…’

While buyers and sellers alike do not have to spend time and money finding each other, brokers take a significant ‘middleman’ cut of the transaction. Moreover, the centralized system has yet to truly deliver, as many brokers entered the market independently. It isn’t so easy to match buyers and sellers, in other words. 

The positives and negatives of going through a broker:   

PositiveNegative
  • Easier to match buyers and sellers
  • Completely above board, following SEC regulations
  • Matches aren’t always as easy as advertised
  • Broker fees 

3. Negotiating a share repurchase

The third liquidity solution for pre-IPO stocks, while uncommon, is negotiating share repurchases. Essentially, your company buys back the stocks they offered you. 

In this case, you can evade the trouble and costs of finding a private buyer, as well as the middleman fees incurred by going through a broker. Share repurchases do not involve questionable violations/circumventions of the terms of your contract either. 

A big reason why they are uncommon (and why you probably won’t get one) is pre-IPO companies may not have enough capital, or may want to use it to exclusively fund growth. Even if the company allows for share repurchases, that doesn’t mean they can actually honor it at any given time. 

Also the perceived value of the company’s stocks (often used to incentivize employees to stay long-term) can drop if they permit pre-IPO liquidity.

The positives and negatives of share repurchases: 

PositiveNegative
  • No extra fees necessary (finding private buyer and broker fees)
  • Completely above board
  • Uncommon/unlikely
  • Limited liquidity (i.e. may not have enough capital for all employees to liquidate)
  • Can’t oversell

4. Selling secondary stock sales

The fourth and final liquidity solution applies only to founders and major shareholders. In cases where those parties want to liquidate their investment, pre-IPO companies execute secondary stock sales from the founder/major shareholder to new or current investors. Risk as well as costs are reduced with this solution. 

Venture capitalists commonly use secondary stock sales to acquire more of the company without diluting other shareholders. 

The positives and negatives of share repurchases: 

PositiveNegative
  • No extra fees necessary (finding private buyer and broker fees)
  • Completely above board
  • Reduced risk for all parties
  • Not available to most employees

Blockchain disruption

While blockchain companies have skyrocketed and plummeted in its short lifespan, the technology seems to have stabilized, and has been experiencing consistent growth. 

As far as pre-IPO secondary markets are concerned, cryptocurrencies present a promising opportunity to make premature liquidity much easier for the many employees forced to wait for their companies to go public.  

Cryptocurrencies/digital tokens, instead of the traditional pre-IPO stock, should allow for employees to easily trade their private stocks without the added costs and risks, especially in the private buyer scenario. The verification process ensures the transaction is (1) securely and public recorded (2) legitimate. Buyers need not be concerned about fraudulent sellers.  

Final Thoughts

While the current liquidity solutions could do with improvements, there are options out there that you should be aware about. You shouldn’t suffer for the loyalty you’ve shown to your company.  

If you’re looking to sell your pre-IPO stocks and make a career change, we’re here to help. 

GrowthAdvisor can help you compare potential job offers, complete with salaries, stock grants, and even potential exit scenarios so you can save time applying to companies that won’t generate you money down the road.

Get started. It’s free

Got questions? Email our team at support@growthadvisorhq.com

Article Number: GA-116

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