Stock Options Relevant Again

One of the tenets of Silicon Valley startup life is that private company stock is worth something.  That is, that the founders of so many statups are justified in choking down PB&Js and Ramen noodles while they struggle to build the new New New Thing because someday the common stock that the founders own by nature of being founders will be worth a whole lot of dough someday.  Further, that the employees and managers of such companies, who are compensated in part by options to purchase the same company stock, are justified in accepting a lower wage -- or less job security – in exchange for the option to purchase those shares of stock.  That’s the way of life for tech startups around the world.  It’s the Silicon Valley model, and it works.

Or does it?  With the great exit eclipse of the last decade, we have seen a paltry number of companies file an IPO – even fewer that have watched their public company stock appreciate rather than decline in the first six months of trading – and a similarly disappointing number of companies exit through M&A.  So the question is this: are the rest of these companies simply gobbling up venture capital only to one day evaporate because they just can’t make a buck?  Are they drifting off into the land of the living dead?  Are they destined to just die on the vine?  No. 

Private companies have needs, and those needs do include access to capital, but private companies don’t need to go public.  And private companies don’t need to be sold. 

On the other hand, investors may need to prove a return on investment in order to continue investing (LPs are, it turns out, serious about wanting to get their capital back, plus some for their trouble).  Founders and employees may need to liquidate some of their holdings for similar, if more personal reasons.  Silicon Valley is an expensive place to raise one’s children after all.  But must we experience a Big Event – an IPO or outright company sale – to achieve such liquidity.  The answer, of course, is no. 

Liquidity can be achieved for certain equity participants through a recapitalization of the company.  That is, a “crossover” VC might invest a tidy sum of money into a company in exchange for a mix of secondary shares (wherein the new money fills the pockets of the founders and/or early stage VCs) and primary shares (the money lands on the company’s balance sheets).  This is not new.  But it’s complicated, and it tends to benefit only a select few major stakeholders -- those who can influence the board of directors well enough to enact such a significant transaction.

With the advent of private marketplaces and institutional secondary stock purchasers there now exists a path to measured liquidity that works a lot like a recapitalization, and yet is more efficient, streamlined, and reaches a broader investing audience.  

Secondary Market Sales and 409As

With the attractiveness and increasing popularity of marketplaces for pre-IPO stock, like SecondMarket, there is growing debate over how transactions in private company
stock impact the value of company securities for 409A purposes.  At the core of these discussions is the question of whether a transaction occurring in a private marketplace is a strong indication of value. In this article we offer guidelines for valuation professionals and company executives to consider when assessing the impact of such secondary transactions on the fair market value of private company stock.

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