March 24, 2021
If you have stock options or shares in a private company / startup, it can be a long wait for the IPO. So you might be wondering:
Can I sell my pre-IPO shares and get some cash instead?
The short answer is yes.
There are secondary markets where you can list and sell your private shares—if someone wants to buy them.
And if you’re in need of cash right away, secondary markets can be an ideal solution.
But—selling comes with some major downsides.
There are alternatives that might be better for you. Let's compare them.
If you do want to sell your pre-IPO shares on a secondary market, the process is pretty straightforward:
If your company’s shares are in high demand, the whole process can go pretty quickly.
But, in many cases, it can take up to weeks or months.
Two of the best known secondary markets are Forge Global (formerly Sharespost) and EquityZen (see our head-to-head comparison of the two here).
While the details differ from platform to platform, the overall process is about the same.
In venture capital and investor jargon, the stock options and shares you own, as an employee, are primary: the company created them specifically for you.
It's the same when a VC firm invests in a startup, or the company raises money in an IPO: new shares are created specifically for these transactions, so they're called primary transactions.
But when you sell your shares to an outside investor, no new shares are created. It's a secondary transaction.
Basically, you can think of it as second-hand shares rather than brand new ones.
Then selling your startup shares on a secondary market is probably your best option.
Keep in mind though, there’s only about 200-300 companies that get listed on these platforms. It’s mostly late-stage, successful startups.
If there’s no demand for your company’s pre-IPO stock, secondary markets won’t do you any good.
Then secondary markets probably aren’t a good fit for you.
We’ll cover the alternatives in just a moment.
But first, let’s go over:
The main advantage to selling your shares on a secondary market is that you’ll maximize the amount of cash you can get right now for your shares.
That’s perfect for startup employees who don’t want to wait for an exit and want as much liquidity as they can get as soon as possible.
But selling on secondary markets has its drawbacks:
While selling on a secondary market gets you cash when you need it, you’re giving up any chance to strike it big in an IPO.
If you don’t feel optimistic about your company’s future—or you think an IPO or exit won’t move the needle on your shares’ value—then secondary markets are perfect.
But Stanford researchers found that for companies that IPO'd within a year, employees who sold their shares in advance of that IPO received 47% less than the IPO value (on average – see study).
In other words, these employees would've earned an additional 47% if they'd waited for the IPO.
And that's without considering taxes, because another drawback of selling pre-IPO is...
If you close a deal and sell your shares, you’ve got to pay taxes on the amount you just made.
And in most cases, you’re going to get taxed at the ordinary income tax rate—the highest tax rate there is.
You won’t get to benefit from the reduced long-term capital gains rate, which could save you up to 31% on taxes.
Most companies (82%, according to Stanford) don’t allow the selling of pre-IPO shares on secondary markets at all.
And almost every company that does allow it will require you to get approval from the board of directors in order to sell.
Since it’s not always in a company’s best interest to let their private shares be sold, many of them often refuse secondary market sales.
Secondary markets are a buyer’s market.
In most cases, you can expect to sell your shares at somewhere around 80% of the current value.
(That’s going by the preferred share price – the price investors paid for their shares during the latest investment round.
As discussed in point #1, if we go by the eventual IPO price, employees get about 53% of that value on average).
All secondary market platforms have a minimum amount of shares you’re required to sell.
It’s usually around $100,000 worth of shares, though it can be higher.
Some platforms will allow you to pool shares with other shareholders, others don’t.
When you ask your company for permission to sell your shares, they reserve the right of first refusal (or ROFR).
Basically, your company has the right to buy the shares back themselves before allowing them to be sold elsewhere.
If you find a buyer and your company pulls a ROFR, you’re still on the hook for the standard 5% platform fee they charge on all deals done.
Because of the company approval process, closing a deal on a secondary market can drag on for weeks and sometimes months.
If you’re on a deadline to exercise your stock options, there’s no guarantee you’ll close the deal on time.
There are two alternatives to selling on secondary markets:
Let's go over the pros and cons of each.
If you want to tap into the liquidity of your shares—but don’t want to lose out on the upside—there’s another alternative: non-recourse financing.
Non-recourse financing is essentially a cash advance that covers:
You only pay that amount back when there’s a successful exit.
If there’s no exit—or your company goes bankrupt—you don’t owe anything.
And since your shares act as collateral for the amount financed, none of your personal assets are on the line.
That opens the door for a number of advantages over selling on a secondary market:
Because the financing company isn’t buying or selling your shares, you get to keep all rights and ownership of those shares.
So if the value of your company’s shares go up and the company goes on to have a killer IPO, you get to participate in that.
When financing your exercise, you can also get a cash advance on top of your exercise costs.
That way you won’t have to wait for an IPO to make use of the value of your equity.
We call this liquidity financing.
It’s not as much as you would get by selling now on a secondary market, but it let’s you keep ownership of your shares.
The single biggest surprise most employees face when they exercise is the size of their AMT (alternative minimum tax) liability.
For many employees at rapid-growth startups, that amount can easily soar past $100K or even $1M (yes, really).
And the higher your company’s valuation—and the longer you wait to exercise—the more AMT you’ll have to pay.
The AMT burden alone can put the cost of exercising out of reach for many employees.
Financing can cover the total cost of exercising before that amount gets any higher.
(Note: you use our free stock option tax calculator to figure out how much you’ll owe when you exercise)
Unlike secondary markets, there’s no minimum amount for how much you finance. You can finance as much or as little as you like.
If you’ve left your company and are facing a 90-day window to exercise, there’s no guarantee that you’ll close a deal on a secondary market on time.
For most companies, we can provide financing in a matter of days (because we've helped some of their employees before). For other companies we still need to do a risk assessment, which takes more time.
Just let us know you're on a deadline, and we'll either let you know upfront that we can't make your deadline, or we'll work hard to get it done in time.
The other alternative to getting cash right away your pre-IPO shares is a tender offer.
Tender offers are when a company offers to buy pre-IPO stock options or shares back from their employees. Or, alternatively, when a company lines up outside investors to buy employee equity in an organised fashion.
It's basically a secondary sale, but organized and sanctioned by your employer.
Some well known companies—such as Airbnb, Dropbox, Pinterest—allow their employees to do this from time to time.
While they come with their own restrictions, the main advantage of tender offers is that you get the full value of your shares according to the latest preferred price (as opposed to selling them for ~80% on a secondary market).
And, of course, a tender is by definition company-approved. So you won’t have to worry about that.
The problem? Very few companies offer them.
You’ll have to check with your company’s HR or financing department to see if it’s an option for you.
Secondary markets are the best option for startup employees who want liquidity as soon as possible, or who aren’t optimistic about their company’s future.
Financing is best for employees who believe in their company’s future, who are looking to save money on taxes (and increase their profit), and/or who only have 90 days to exercise their options—and need cash to make that happen.
Tender offers may also be an alternative if you’re in need of cash—but only if your company offers them.
If you want to know if non-recourse financing is available to you, and at what rates, check www.secfi.com/products/options-exercise.
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