Equidate Launches A Secondary Market For Early Startup Employees To Sell Shares(techcrunch.com)
techcrunch.com
Equidate Launches A Secondary Market For Early Startup Employees To Sell Shares
http://techcrunch.com/2014/01/30/equidate/
8 comments
One of the biggest reasons people sell private stock on the secondary market is because the want (or need, in the case they leave) to exercise options and pay the associated taxes. Early Twitter, Facebook etc... employees who left had the standard 90 days to exercise options. The good news is that an option exercise might only be $30k, the better news is the stock was worth $15 million the bad news is the tax bill was $6+ million - probably more than Mom or Uncle Willy could lend! Hence a stock sale. The other big reason people sell is life happens, i.e. after 5+ years earning $150k in the Bay Area doesn't buy a new house after you get married and have kids. I've done hundreds of deals and the reasons for selling are very consistent. But there are definitely issues with the proposed structure of Equidate. Happy to discuss with anyone [email protected]
Regarding the SEC's 500
shareholders' threshold
for public disclosure of
financial statements, any
shareholder has the right
to examine a corporation's
books and records.Walk me through the mathematics of why an Employee at a startup they believe in and have vested equity in would sell that pre-IPO to an investor?
Can you provide a few scenarios? I imagine other HN readers are curious too, especially given our(collective) lack of experience with IPO's....well at least mine.
Can you provide a few scenarios? I imagine other HN readers are curious too, especially given our(collective) lack of experience with IPO's....well at least mine.
Imagine your net worth consists of 100k cash, and a lottery ticket which, by your reckoning, has 15% chance of being worth 1m, and an 85% chance of being worth zero. Imagine further that you won't know the outcome until 3-5 years from now.
Let's forget the time value of money for a moment. The expected value (mean value under all possible future scenarios) is 15% x 1m, i.e. 150k. This is more than half your net worth.
Wouldn't you give an investor a discount if he agrees to buy half of the lottery ticket? It would get rid of the 85% chance that you lose over half your net worth through an outcome over which you have only limited influence.
Also, you can buy stuff with cash. Today.
Let's forget the time value of money for a moment. The expected value (mean value under all possible future scenarios) is 15% x 1m, i.e. 150k. This is more than half your net worth.
Wouldn't you give an investor a discount if he agrees to buy half of the lottery ticket? It would get rid of the 85% chance that you lose over half your net worth through an outcome over which you have only limited influence.
Also, you can buy stuff with cash. Today.
Plus, you might not even have enough cash to exercise your options before they expire.
I see. That makes sense. Well put. Are you on the team?
Thanks.
No, I'm not on the team.
No, I'm not on the team.
A couple of other commenters have basically mentioned risk hedging -- that is, the concept that you might think that your company is a good one that has better-than-usual chances to monetize, but recognize that even good companies fail. They're right, and that's one reason.
The other reason is liquidity. Sometimes you want money now, not in a few years. Maybe you need to buy a house, or you want to start your own business (and thus not have a salary income for the next two years or more), or you or your spouse are pregnant, or you just decided you have to have a new Model S.
The other reason is liquidity. Sometimes you want money now, not in a few years. Maybe you need to buy a house, or you want to start your own business (and thus not have a salary income for the next two years or more), or you or your spouse are pregnant, or you just decided you have to have a new Model S.
Maybe as an Employee, you know that your startup is crap and won't go public or will below the IPO price (e.g., GRPN) and you can milk the investors when the impression is better than it seems before IPO. Also typical IPO has a one year lockup period, so it's not like you can cash out the day when a IPO is suppose to skyrocket but have to wait out a whole year while the cooler heads prevail and analyzes your books and 4Q of earnings to analyze your burn rate and revenue.
So, insider trading essentially.
So, the textbook answer people will give you is risk diversification - even if you believe in the company, why keep all your eggs in one basket?
While there is some truth to this, there is also this: https://en.wikipedia.org/wiki/The_Market_for_Lemons
Basically, the risk is that people most likely to want to sell are those with some suspicion that there is a problem, buyers are therefore suspicious and demand a discount, this in turn drives out people with stock in good companies since they don't want to sell at a big discount, and the market collapses...
While there is some truth to this, there is also this: https://en.wikipedia.org/wiki/The_Market_for_Lemons
Basically, the risk is that people most likely to want to sell are those with some suspicion that there is a problem, buyers are therefore suspicious and demand a discount, this in turn drives out people with stock in good companies since they don't want to sell at a big discount, and the market collapses...
Everyone believes in their company, even the people who work at companies that turn out to be duds.
If 90% of your wealth exists only in the theoretical value of your pre-IPO stock, that's not a good balanced portfolio.
If 90% of your wealth exists only in the theoretical value of your pre-IPO stock, that's not a good balanced portfolio.
>>Everyone believes in their company, even the people who work at companies that turn out to be duds.
Why would this be true? If desperate, I'm willing to work for any (non-evil) company I believe can pay me what they owe. The product can be absolute garbage that'll never sell, that's not really my problem. It would obviously impact my valuation any stock options, but that's another story.
(I'm happy to work at a place I do believe in - although I'm still glad they pay cash and not stock).
Why would this be true? If desperate, I'm willing to work for any (non-evil) company I believe can pay me what they owe. The product can be absolute garbage that'll never sell, that's not really my problem. It would obviously impact my valuation any stock options, but that's another story.
(I'm happy to work at a place I do believe in - although I'm still glad they pay cash and not stock).
Everyone?
Sometimes a liquidity event is quite a ways off. This is partly why founders of Groupon, early employees of Facebook, etc... sold to secondary markets even when their companies were quite promising. People like money today more than money tomorrow.
> with or without the startup's consent
I'm not convinced this is possible in the long run.
The idea seems to be that employees can't sell the shares themselves, but can sell the kind of derivative around which Equidate is based. That may be true at the moment, in that the employees may not be contractually forbidden from writing such a derivative. But if companies currently forbid sales of the shares themselves, won't they eventually get wise and start to forbid sales of derivatives as well?
I'm not convinced this is possible in the long run.
The idea seems to be that employees can't sell the shares themselves, but can sell the kind of derivative around which Equidate is based. That may be true at the moment, in that the employees may not be contractually forbidden from writing such a derivative. But if companies currently forbid sales of the shares themselves, won't they eventually get wise and start to forbid sales of derivatives as well?
IIRC Google explicitly bans employees from trading in any derivatives of the company stock (other than incentive stock options issued by the company). I'd assume that is standard boilerplate at other companies as well.
Yes, this is a very common restriction in employment contracts (or in other corporate policies that are just as enforceable).
Companies may not care as much about the derivatives. This doesn't add shareholders so it wouldn't trigger a reporting requirement. It does change the employee's incentives but so does a restrictive contract.
I don't understand why companies would want to prevent employees from selling stocks. Most startup equity is worth very little. Giving employees more options to sell said equity makes it worth more which also makes it a more effective means of recruiting employees.
There are a number of reasons for it, one they can constrain what employees do, but they can't constrain what 3rd parties do. Investors are bound by their term sheets, employees by their employment agreements, and these people who hold stock and are 'unbound' might cause trouble. (not that they will its just that if they do the company has a limited number of ways to respond)
They can't cause any trouble until the employee shares have been delivered, which would be at the same point that the employee could unload the stock via other means; until that point, all they have is a contract with the employee.
Perhaps we have different ideas of what "trouble" is :-). My experience is that 'qualified investor' can often be substituted for 'troublemaker' but it may just be coincidence.
One reason that hasn't been mentioned is external sales are considered a valuation event for the purposes of valuing option offers for new hires.
Especially when liquidity is so low, these secondary offerings result in ridiculous valuations on a very small amount of shares, but that really hurts the ability of the company to offer low strike prices on options to attract talent.
Especially when liquidity is so low, these secondary offerings result in ridiculous valuations on a very small amount of shares, but that really hurts the ability of the company to offer low strike prices on options to attract talent.
I forget the exact number, but I think if a private company has >= 500 individual shareholders, that triggers an SEC requirement for public disclosures. So this kind of trading activity could force a company to, e.g. reveal that it's not yet profitable, or it's been astroturfing growth on it's current hot app.
It's not actually trading stock or adding shareholders. It's collateralizing the shares, much like you mortgage your home. They simply front you money with a lien against your shares.
Don't early employees of startups get incentive stock options, which are not forbidden to be derivative-traded on?
Something very common in the poker tournament world is equity swapping. In any given tournament a player might swap 5-10% of their action with one or more other players. This is a way to reduce variance while maintaining similar equity (assuming roughly equal skill levels).
Why isn't there a service for allowing employees at different startups to swap their equity to reduce their variance?
Why isn't there a service for allowing employees at different startups to swap their equity to reduce their variance?
Because private companies don't want to lose control of their shares. When too many outsiders hold your shares, bad things happen (i.e. the SEC starts treating you like a public company).
For this reason, most equity plans have a right of first refusal. Your ability to trade restricted shares to outsiders is limited.
For this reason, most equity plans have a right of first refusal. Your ability to trade restricted shares to outsiders is limited.
IOW, regulation creates an significant limitation for individuals (being able to sell their shares), for the supposed benefit of individuals (forcing companies to publicly report), even if the selling individual and buying individual are both perfectly fine with the private transaction and situation. This limiting of individuals is of course for their own good, and such limitations are greatly reduced for the wealthy, who can simply bypass the individual and buy direct from the company.
As someone who once had significantly valuable equity in a company that eventually failed, and who asked and was denied the sale of some of that equity, I would have welcomed an opportunity to trade some of that upside to secure against the downside.
As someone who once had significantly valuable equity in a company that eventually failed, and who asked and was denied the sale of some of that equity, I would have welcomed an opportunity to trade some of that upside to secure against the downside.
Of course you would have welcomed it. But you're missing the point: companies don't want you to sell their private shares, either. If nothing else, it's a logistical headache that they don't need.
This isn't a story of "big government" -- it's better for everyone (except perhaps you) if it's difficult for you to sell your private shares on a secondary market. The company maintains better control of share pricing and internal information, you have a (sometimes strong) incentive to stay an employee if you can't liquidate your shares on a moment's notice, and it helps to keep scammers out of the equities market.
This isn't a story of "big government" -- it's better for everyone (except perhaps you) if it's difficult for you to sell your private shares on a secondary market. The company maintains better control of share pricing and internal information, you have a (sometimes strong) incentive to stay an employee if you can't liquidate your shares on a moment's notice, and it helps to keep scammers out of the equities market.
Founder's Institute does exactly this for their cohorts:
http://fi.co/faq#fees (see the optional fees)
I can see two practical problems with this, and am curious about how they deal with them:
- The investors will not be entitled to the same information as stockholders, which will limit their ability to properly value the shares. This, in turn, should increase their risk perception and lower the price they offer.
- Even if the contract between the investor and the employee is sound, the employee could fail to deliver the stock for a number of reasons, including violating something in their employment agreement, or due to onerous provisions among the vesting terms. (Companies have been known to pull back securities which were already vested at the time the employee left.)
- The investors will not be entitled to the same information as stockholders, which will limit their ability to properly value the shares. This, in turn, should increase their risk perception and lower the price they offer.
- Even if the contract between the investor and the employee is sound, the employee could fail to deliver the stock for a number of reasons, including violating something in their employment agreement, or due to onerous provisions among the vesting terms. (Companies have been known to pull back securities which were already vested at the time the employee left.)
Regarding the second point, failure to deliver is an insurable risk, and would probably spawn a related market in derivatives. Anyone trading the contract on the shares that the employee wishes to sell will probably go over the employment agreement and the corporate bylaws very carefully in order to assess this risk.
Under what conditions have employers been able to pull back shares that are already vested without being sued into oblivion?
Under what conditions have employers been able to pull back shares that are already vested without being sued into oblivion?
Regarding the second point, failure to deliver is an insurable risk...assess this risk.
Yes, but whoever insures the risk would face the same difficulty in getting enough information to properly assess the risk. I'm not saying it's not doable. However, it might not be doable well enough, and cheaply enough, that there's enough margin of safety for the investor, above the lowest price at which the employee would be willing to 'sell'.
Under what conditions have employers been able to pull back shares that are already vested without being sued into oblivion?
Skype pulled back options that were already vested: http://finance.fortune.cnn.com/2011/06/24/skype-vesting_cont...
I'm not aware of any similar instance for vested shares.
Yes, but whoever insures the risk would face the same difficulty in getting enough information to properly assess the risk. I'm not saying it's not doable. However, it might not be doable well enough, and cheaply enough, that there's enough margin of safety for the investor, above the lowest price at which the employee would be willing to 'sell'.
Under what conditions have employers been able to pull back shares that are already vested without being sued into oblivion?
Skype pulled back options that were already vested: http://finance.fortune.cnn.com/2011/06/24/skype-vesting_cont...
I'm not aware of any similar instance for vested shares.
Look at how SharesPost and secondMarket have already solved the first problem.
He second problem is just a special case, one risk.
He second problem is just a special case, one risk.
Look at how SharesPost and secondMarket have already solved the first problem.
They've solved it for more later-stage, pre-IPO companies. I'm not sure they've solved it for less well-understood companies which have raised Series A or B. I haven't looked deeply into this, so I'm prepared to stand corrected :)
They've solved it for more later-stage, pre-IPO companies. I'm not sure they've solved it for less well-understood companies which have raised Series A or B. I haven't looked deeply into this, so I'm prepared to stand corrected :)
It’s similar to a collateralized loan. No shares are trading hands.
It actually sounds kind of like a convertible bond that you might have in an early stage VC round, except that instead of the company issuing shares when the conversion happens, it's the founder/employee "converting" from their already issued shares. The convertible bonds can trade just like well, like other bonds trade.
Given that they haven't even managed to acquire "equidate.com" (currently goes to an all comic sans site for "Equine Event Dates & Places") we have to assume this is a pretty early stage / MVP type of company.
Ultimately this comments thread could really use some input from a knowledgable VC or lawyer...
It actually sounds kind of like a convertible bond that you might have in an early stage VC round, except that instead of the company issuing shares when the conversion happens, it's the founder/employee "converting" from their already issued shares. The convertible bonds can trade just like well, like other bonds trade.
Given that they haven't even managed to acquire "equidate.com" (currently goes to an all comic sans site for "Equine Event Dates & Places") we have to assume this is a pretty early stage / MVP type of company.
Ultimately this comments thread could really use some input from a knowledgable VC or lawyer...
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