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.
If you’re in need of cash right away, secondary markets can be an ideal solution.
How do secondary markets work, and what are the alternatives? Let's discuss.
Secondary markets are platforms where you can buy and sell private company shares. They’re best for people who want cash now (or who think their company's value has peaked). If you sell on a secondary market, you give up any upside to your shares (and you’ll have to pay taxes).
Non-recourse financing (or exercise financing) is an alternative for startup employees who want to tap into the liquidity of their options without giving them up, who think their company’s value will continue to rise, or who simply need help financing the cost of exercising their options (especially on a deadline).
Some companies allow employees to sell their stock options back to the company in a tender offer—but this is still relatively uncommon.
How to sell shares of a private company on a secondary market
If you do want to sell your pre-IPO shares on a secondary market, the process is pretty straightforward:
- You choose an online platform
- You set the price and quantity of shares you want to sell
- A broker gets assigned to you
- Your broker tries to match you with a buyer
- If you find a buyer, you seek approval from your company
- If you get company approval, you close the deal
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 here).
Many secondary platforms are not available to the general public. However, through Secfi Secondaries, we can reach out to a larger network of buyers to find you the best deal, as well as negotiate price.
Why are they called 'secondary' markets?
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 secondhand shares rather than brand new ones.
So, should you sell your private company stock?
- You need of a large amount of cash right now
- You don’t want to wait for a future IPO or exit for a payout
- You don’t think your company’s value is going to increase
- You’re willing to pay the highest tax rate on your gains
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.
When not to sell your shares on a secondary market
- You want some liquidity, but don’t want to give up the upside on your shares (or options)
- You want to get the most potential long-term value out of your options (and are willing to wait for an IPO or exit)
- You’ve left your company and have 90 days to exercise your options
- You can’t meet the minimum sale amount required by the secondary market platform
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 advantages and disadvantages of secondary markets for private shares
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:
1. You lose the upside on any shares sold
While selling on a secondary market gets you cash when you need it, you could be giving up any chance to experience additional gains following an exit.
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...
2. You’ll get taxed at the highest possible rate
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.
3. You need company approval
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 refuse secondary market sales.
4. You'll probably sell at a steep discount
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).
5. You'll have to sell at least $100,000 worth of equity
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.
6. You may run into ROFR
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.
7. The process can take a long time
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.
So, what are the alternatives to secondary markets?
There are two alternatives to selling on secondary markets:
- Non-recourse financing
- Tender offers
Let's go over the pros and cons of each.
1. Non-recourse financing
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:
- Your strike (or exercise) price
- Any tax burden that exercising triggers
- Additional liquidity for you to use however you like
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:
A. You get to keep the upside
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.
B. You can get liquidity before an IPO
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 lets you keep ownership of your shares.
C. You can keep your AMT liability down
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.
D. There's no minimum transaction size
Unlike secondary markets, there’s no minimum amount for how much you finance. You can finance as much or as little as you like.
E. If you're on a deadline, financing can move quicker
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.
When non-recourse financing is right for you
- You think the value of your company will continue to rise
- You want to get the highest long-term value out of your options
- You don’t have the cash you need to exercise your options
- You are willing to wait until your company’s exit to sell shares
- You want to maximize your tax advantage
- If you left your company and only have 90 days to exercise your options
When non-recourse financing is not right for you
- You think the value of your company has reached its peak and won’t go any higher
- You are “cash hungry” and want to get your hands on as much cash as possible — right now
2. Tender offers
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 organized 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 gains), 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.
At Secfi, our team of financial advisors can help advise you on what is best for your personal situation. If selling on the secondary market is the right move, we can help you sell your shares through our network of secondary markets, buyers, and other participants. If securing financing is a better fit for your goals, we offer exercise financing. Either way, our goal is to help you understand your options so you can make the most informed decision.