You may be able to sell your later stage startup shares in the secondary market.
Employees of startups often receive equity as part of their compensation. If there is a sale of the company, or more rarely an IPO, the employees may receive a significant payout. In reality, however, if employees leave before a sale or IPO, they have 3 months to exercise their vested stock options but rarely do thereby losing the benefit of any upside.
Assuming, however, that employees do have vested options or stock, is there any way for the employees to obtain liquidity before an IPO or sale event? While a few, but an increasing number of, companies have initiated programs to buy back employee shares, most employees would need to turn to the secondary market.
- The secondary market is a private exchange run by companies such as SharePost and SecondMarket that matches buyers and sellers of private shares.
- Shares from companies that are household names or close to an IPO will have the most vibrant market.
- Employees placing shares on the secondary market will typically receive a Commission Agreement from the broker and a Common Stock Purchase Agreement between the employee, as seller of the stock, and the buyer. The Company may also require a legal opinion. Employees will generally engage counsel to review these documents and prepare the legal opinion.
- Companies, in order to manage the shareholder base of the Company, impose restrictions on the transfer of stock that the employee needs to be aware of in a secondary sale. These restrictions are often contained in the original Grant Agreement and in the governance documents of the company, typically the Bylaws. The employee should be aware of these restrictions before embarking on a secondary sale. The restrictions will generally provide:
- the company needs to consent to any transfer of the shares (other than for estate planning purposes); and
- a right of first refusal in favor of the company – meaning the company has the option to purchase the shares first on the same terms offered to the third party buyer.
- The employee should be aware of other restrictions – such as the company’s right to repurchase vested stock (a less common restriction) – which would preclude any secondary market transaction.
- The sale needs to be made in compliance with the US securities laws. All sales of securities must be registered (as in an IPO) or rely on an exemption from registration. The exemption often used in a secondary sale of securities is Section 4(a)(1½). This exemption has a number of requirements, including that the purchase is for the purchaser’s own account, the purchaser had access to information it considers reasonably important, the purchaser is an accredited investor, there is no general solicitation and the purchaser acknowledges that the shares remain restricted.
- The employee should engage a tax advisor to determine how the gain on sale will be treated. Depending on the circumstances, part of the gain may be treated as ordinary income rather than capital gains at the lower rate.
If you require any further information about selling late stage shares, please contact Edward Grenville, Managing Shareholder, Inspire Business Law Group, PC (email@example.com; +415 279 0779; www.inspirelawgroup.com).
This article is provided for educational and informational purposes only and is not intended to be, and should not be construed as, legal advice.