Founders and employees
It should come as no surprise to a founder or employee of a venture-backed company that other shareholders and stakeholders in the company would have concerns regarding the sale of stock by an insider.
In public markets, insider buying and selling is closely regulated, tracked and generally seen as an indication of insider concern regarding the company’s prospects. It is no different in a private company – and sometimes worse. Since the shares in privately held companies are not actively traded in an open market, the ability for some people to achieve a liquidity event while others (i.e. venture investors) may not be able to do so, can cause some
Furthermore, since management and employees are crucial to the ongoing
growth of a company and in achieving a liquidity event, many companies and investors are concerned that allowing employees to sell their shares before an exit event will diminish their motivation. That being said, there are several situations when it is reasonable for employees,management and founders to search for some liquidity through a secondary transaction.
Changes in personal financial or family situation – To the extent that an employee is having a child, has to move to meet the requirements of a growing family, or has financial needs to pay for unexpected health care expenses, parental obligations or tuition, it is entirely reasonable to search for some liquidity from their ownership in a privately held company.
Differences of opinion amongst the founders, management and investors on when to sell the company – The decision to sell a company early versus taking more capital and building the company for long-term success often highlights the risk/return differences between investors and management teams. Allowing some liquidity to founders or early employees can reinvigorate their desire to build the company and aim for a larger exit by relieving some of their financial concerns and providing a capital cushion for their family.
Employee departures or changing roles inside a company – When a founder has been replaced as CEO or an executive’s role inside the company has been changed, it is expected that, concurrent with that event, an employee wishes to sell some or all of their stock. In these situations, it is prudent, as part of any termination arrangement, to provide the employee the ability to sell a portion or the entirety of their shares in the company and for the company to cooperate with one or two sophisticated institutional buyers in that process, including waiving any transfer restrictions on the shares (assuming the employee or founder is leaving on good terms).
Diversification – A founder or employee whose net worth is either entirely or significantly held in a single private company and who has worked at the company for several years (i.e., at least four years) has a strong rationale to sell a minority portion of their stock in the company. As long as a meaningful amount of stock is still held by that employee or founder such that their interest are still aligned with the company’s goals, providing some liquidity to a long-time employee is entirely appropriate.
Tax planning, estate planning or other financial planning needs – Many early
employees who own a substantial number of options may want to exercise those options sell some of their options through a secondary transaction in order to get capital to exercise their remaining options. Similarly, a secondary transaction can help an employee manage the sale of their stock to optimize capital gains tax, AMT laws, or aid in estate planning.
Expiring stock options or other stock awards – Due to the extended liquidity timelines for venture-backed companies, employees frequently find themselves holding stock options or other stock awards that are close to their expiration date. In these situations a company may choose to allow an employee to sell a portion of options on the secondary market to provide capital so that they can exercise their remaining holdings