December 5, 2018
Private Companies: Secondary Markets for Employee Equity
– Liz Dunshee
My husband recently interviewed with a start-up – and like many private companies, a big portion of the pay package was equity. If you’re an optimist who thinks you’ve found the next Uber – and you don’t expect any major expenses before their potentially far-off liquidity event – that’s pretty exciting. But if you’re married to a securities lawyer who tends to see more risks than benefits…you keep looking.
That said, maybe we’ll revisit the discussion now that this Stanford memo has compiled info & stats about resale restrictions, the secondary market and average discounts. Based on a sample of 34 companies, 56% allow employees to sell or pledge a portion of their vested equity awards. Among those that allow sales:
– 67% allow sales back to the company
– 40% allow sales on a secondary marketplace – e.g. SharesPost, Equidate, EquityZen, Nasdaq Private Market
– 47% allow sales to third-parties not through a private company exchange
– 7% allow pledges.
– Employees who sold averaged a 39% discount to subsequent IPO pricing
As you’d guess, many companies have a right of first refusal. What surprised me was that 40% of companies allow employees to sell at any time at their own election – and 14% don’t require any company approval. And here’s one other thought to chew on:
Perhaps more important for the company is that allowing the sale of vested equity awards potentially distorts employee incentives. In structuring their compensation programs, companies decide on the correct mix of cash and equity to attract, retain, and motivate employees to pursue company objectives. An employee who is allowed to sell vested equity awards is effectively being allowed to convert variable, performance-based pay to a fixed amount of cash, significantly reducing (and distorting) the future incentive value of the compensation program.