In our last Founders + Funders issue, Vieje gave some insight and tips on how to navigate the secondary markets. With the IPO window still closed (though, hopefully reopening towards the end of the year), we’re hearing from more people in the startup community that are interested in liquidity options.
For this week, I wanted to make the assumption that you do have the opportunity to sell. And, if you do, how do you decide whether to sell now or hold out for the IPO?
The simple answer? It depends. And that’s the unfortunate reality about private equity. There are a number of factors to consider both when valuing it (though our new, free Job Offer Analyzer helps — sorry, had to plug!) and deciding what you should do with it. That’s why you need to have a plan for your equity, to align it with your overall financial priorities so you can make informed decisions.
What is an equity plan? That’s one of the most frequently asked questions I get. But, having one helps you decide if you should sell in a tender offer, on the secondary market, or hold out for an IPO.
To give you more specific context on what this actually looks like, I’m going to share a couple examples of clients I worked with so you can see the decisions they made and the factors that went into them.
If you’re pondering a similar scenario, or just want a better handle on your financials and equity, you can always feel free to put some time on my calendar.
You can also sign up for our upcoming live session with CJ Gustafson, current tech CFO and author of Mostly Metrics, where he’ll share his experience with equity, including the difficulties around liquidity decisions. Even if you can’t make it, we’ll send you the recording!
🔑 Diversification isn’t always the key — planning is
While most financial advisors would recommend selling and diversifying your investments, I believe selling now or holding out for a future liquidity event are both reasonable options. Everyone’s situation is unique, so there is no one-size-fits-all approach to this.
Here’s what your framework should include:
- Your company’s business outlook: Do you think an exit (IPO, M&A) is likely? In how long? This could help you decide if you want to wait or not.
- Annual 409A re-evaluations and fundraising: Companies need to have their 409As re-evaluated once a year and any time there’s a material update, like a funding round.
- Your current, and future, cash needs: Do you need cash now for living expenses, a down payment on a house, a new car, a family vacation, etc. or are you focused on your nest egg for retirement?
- Your risk tolerance: Are you comfortable missing out on liquidity today in hopes that it’ll be worth more later knowing that may not be the case? Or, are you ok selling in a tender today knowing the value could increase after an IPO?
- Your career plans: Do you plan to stay with your current company for the long-term, or do you think you could move on in the next couple of years? You don’t want to lose your investment just because you have career goals that may take you elsewhere.
- The spread between your strike price and 409A: This is what you’re taxed on. Usually, 409As tend to go up, creating a higher tax bill. But, in this environment, many have been lowered to match public markets, meaning you could have an opportunity to reduce your tax liability.
It’s also important to note that these decisions are not black or white. You don’t need to exercise it all, sell it all, or do nothing. Inaction is one of the most common things I see, and it’s usually one of the most costly. Not just from a financial perspective, but it often leads to people making less-than-ideal decisions because they’re forced to.
For example, someone not doing anything with their equity and then they’re recruited for a great role at another company. But, now they have a 90-day ticking clock to figure out what to do with the equity at their former company — which they still believe is great! — before it all expires.
Similarly, if you have the opportunity to sell in a tender offer, you could get some immediate cash for a house project, a new car, or even an international vacation with your family. These are all viable reasons to sell some shares, rather than not participating because you think the value is too low, or that an IPO may be around the corner.
🌍 Let’s look at real world examples of Stripe employees
I recently partnered with two Stripe employees who faced this exact decision.
Stripe’s impending tender offer — which they raised $7B to foster — is a good example of how to make a decision. An opportunity to sell some shares? Great! But Stripe also raised that capital at a much lower valuation: $50B, down from a high of $95B.
Could that valuation increase again? Of course! They’re one of the strongest late-stage startups out there. But, as my colleague John always says about investing: Don’t try to predict the future.
Here’s some more context on each of these individuals:
Based on the latest Fair Market Value (which is similar to the 409A), they both have ~$3 million worth of Stripe equity. Pretty nice situation to be in! 🙌
Both are optimistic on Stripe's prospects for the future, so they’re a bit disappointed with the current valuation, which is down nearly 50% from two years ago. Hence, both individuals are not eager to sell much of their Stripe stock in the upcoming tender offer.
But both of them were seeking advice on how to approach the decision, and if it could make sense to sell. If so, should they sell NSOs, ISOs, RSUs (now common shares since their RSUs vested)?
🙅♂️ Stripe employee 1’s plan:
For the first individual, we concluded that he is not going to participate and sell stock in this tender.
Stripe stock is by far his single largest asset, so we discussed the risks associated with any one security making up a significant (~50%) portion of his net worth and what opportunities that a financial windfall could provide for him today.
He understood both the risks of owning a concentrated stock and the opportunities he is sacrificing by not taking liquidity now during this event.
My role as the advisor is to educate him on the benefits and drawbacks of each scenario, identify blindspots he may not see, and ultimately help him to make an informed financial decision. He did just that.
So why did we conclude not to sell any stock?
- He had previously gone through a significant liquidity event when his former company IPO'd and he used these proceeds to diversify his investment exposure & secure a base-level of financial independence.
- He is single, rents a place in Seattle, and has no dependents or financial obligations.
- His objective for the proceeds is to invest in other entrepreneur's business ventures.
🙋Stripe employee 2’s plan:
For the second individual, though she has a similar amount of Stripe stock, we concluded for her to sell 33% of her stock in this tender.
So why was my recommendation for her to sell a third of her stock, but not the same recommendation for the other individual who has a similar amount of Stripe stock?
Rule #1 of personal finance: It's personal.
Her personal situation is vastly different from his situation. Here's a brief overview:
- Stripe stock currently makes up > 90% of her net worth.
- She and her husband are expecting their second child this fall and anticipate their expenses to increase to cover childcare.
- 80%+ of her Stripe holdings were vested, but unexercised, stock options.
With the proceeds from her tender offer sale, we developed a plan for her to:
- Cover the additional tax liability associated with her RSUs vesting (Vieje covered this in his update about the Stripe fund raise)
- Exercise and hold 50% of her vested stock options + cover any taxes due
- Use the remaining proceeds to build up cash reserves and reinvest into a diversified investment account
This approach reduces her concentration risks, allows her to retain additional upside, creates greater flexibility from a financial and employment perspective, and aligns with the objectives she has for her family. All benefits that are moving her closer to becoming financially independent.
🤷 So…what should you do?
First of all, your pre-IPO liquidity options may be limited. Yes, I’ve worked with employees at late-stage companies like Stripe and SpaceX navigate tender offers, but not all companies offer these. More late-stage companies could begin to offer them, if they already don’t, due to expiring equity grants (the main reason Stripe is).
And yes, there are a number of secondary markets that are still active. But, you’re more likely to find buyers for late-stage companies closer to exit, not all companies allow it, the timeline for finding a buyer isn’t always clear, and some have minimum transaction amounts you may not want to meet.
Could this change, especially for earlier-stage companies? Sure! The last two years have shown the risk of companies waiting longer and longer to exit — you get expiring equity grants and an inability to access liquidity could impact employee morale.
But for those that are given liquidity options, they should approach them armed with as much information about how it affects their financial position as possible. And, even for those that aren’t up against these types of decisions, creating a plan now for your equity is always a good idea, so you don’t find yourself thrown into a situation where you suddenly need to make a decision, and have to start from scratch.
Remember, it’s not an all-or-nothing decision and the goal is really to create flexibility for yourself financially and in your career, while also reducing the risk associated with startup equity. Even if you make a plan, you may want to make adjustments along the way. Financial plans are never set in stone!
If you do want to get a better understanding of how your equity fits into your financial situation, or if you have the opportunity to sell, put time on my calendar and I’m more than happy to answer your questions.
Things we’re digging:
- 🤷 Not sure what to do with your equity? Join me on June 15 where you can hear from CJ, a successful startup exec, about how he’s grappled with equity decisions throughout his career.
- 🤤 Any IPO news whets the appetite. All eyes are on Cava, which is expected to IPO at a potential $2B valuation. It may not be the type of tech IPO we’re all waiting for, but many will surely be watching to see if they may want to open the window a bit more.
- 🪙 Pour one out for crypto. It’s been another tough week for the crypto community with SEC filing lawsuits against both Binance and Coinbase. What happens next is anyone’s guess, and could take years to litigate, but it’s likely we’ll continue to see ups and downs as regulators continue to look at the industry.