In today’s economic climate, more private company employees may turn to liquidity providers to help generate cash and maximize their net worth. And as a leading liquidity provider, we frequently receive questions from these employees about how private stock liquidity and option-exercise transactions work and why you may want to work with a liquidity provider.
To help demystify the space, we sat down with our Founding Partner, Robert Pitti, to answer your most frequently asked questions.
What is a private stock liquidity solution?
A private stock liquidity solution is a transaction where a third party provides capital to a private company shareholder to finance their option exercise or generate liquidity in lieu of a secondary sale. The private company shares act as collateral for the transaction.
Why is understanding my liquidity options important?
Understanding your liquidity options can help you optimize taxes, reduce risk, and help maximize your net worth. If you need money to exercise your options or money backed by private company shares to address cash needs, a liquidity transaction may be able to help you realize your financial goals and dreams while also benefiting from any future share appreciation.
Why would I want to work with a liquidity provider?
It’s no secret that private companies are staying private for longer than ever before. And as a result, there has been an increase in options and equity holders looking for liquidity before a company sale or IPO. For most shareholders, cash needs are often not in sync with a company’s exit plans or underwriting calendars. Working with a liquidity provider can be an attractive way to generate cash from illiquid private company shareholdings.
Who is a good candidate for a private stock liquidity transaction?
Many private company option holders or shareholders are attracted to the benefits of these solutions —receiving cash today without sacrificing future potential equity upside—but both the benefits and downsides must be analyzed case by case. An ideal liquidity candidate has a current need for liquidity to exercise options or other financial purposes and has a firm belief in the continued success, and ultimate exit, of the company.
When is the right time to seek a private stock liquidity transaction?
Private stock liquidity transactions are generally available in leading later-stage, venture-backed companies with a reasonable expectation of an exit in the next 36 months. Often, it is desirable to arrange an option exercise private stock liquidity transaction at least 12 months prior to an exit to secure long-term capital gains treatment. Financial solutions for liquidity can happen anytime a secondary sale would make sense for the shareholder. From a practical standpoint, getting a private stock liquidity transaction is only feasible in companies where the capital provider has performed a meaningful amount of research on the merits and financial viability of the company.
How is Liquid Stock’s private stock liquidity transaction structured?
Our solutions are structured as non-recourse transactions1, meaning that only the value of the private shares is used as collateral, with no need for a personal guarantee. Compared to a loan or sale of shares, this solution can reduce risk, optimize taxes, and maximize potential upside. In addition, our transactions do not have a fixed term and are only paid off when there is a future liquidity event. In other words, Liquid Stock gets paid when you get paid. Our transaction may also provide meaningful tax benefits compared to a traditional loan2.
How can private stock liquidity transactions benefit option holders?
Private stock liquidity transactions can help option holders exercise their options today without covering the cost out-of-pocket. By providing the option exercise cost and tax bill due upon exercise, a private stock liquidity transaction can preserve significant cash value that would otherwise be forfeited or paid in taxes. And, because the transaction is non-recourse1, the shareholder’s responsibility for repayment is limited to the value of the shares securing the transaction.
A private stock liquidity transaction provides option holders with the following benefits:
- Can reduce taxes by allowing option holders to exercise their options and start their long-term capital gains holding period before selling the underlying shares
- Can reduce risk because non-recourse1 transactions do not require the shareholder to put personal assets at risk. The capital provider takes the risk of company failure.
- Provides departing employees a way to hold on to their hard-earned equity
How can private stock liquidity transactions benefit shareholders?
Private stock liquidity transactions allow private company shareholders to get liquidity without selling their shares. Using their private stock value as collateral, shareholders can get cash today while maintaining more equity upside than they would through a secondary sale.
A private stock liquidity transaction provides shareholders with the following benefits:
- Provides access to cash today
- Can increase long-term equity value compared to a sale in companies that continue to appreciate in value
- Can reduce risk because non-recourse1 transactions do not require the borrower to pledge personal assets. The capital provider takes the risk of company failure.
The bottom line is: In most cases, for shareholders or option holders who are looking for liquidity but want to continue participating in the company’s future success, a private stock financing transaction is worth exploring.
To learn more about private stock liquidity transactions, stay tuned to our content hub “The Drip” as we continue to demystify the space with Q&As with Robert Pitti.
1 As used herein, “non-recourse” means that a transaction counterparty is not personally liable for the difference between the value of the advance made to the counterparty and the value of the collateral shares upon a liquidity event or upon such other time(s) as defined in the transaction agreement, if the value of the collateral shares is less than the advance or other amount owed. In Liquid Stock transactions, the Counterparty will be personally liable in certain enumerated “Events of Default” defined in the applicable transaction agreement. These events include but are not limited to, failure to pay amounts owed under the agreement when due, breach of representations and covenants, and transfer of collateral shares in violation of the transaction agreement. Following such an “Event of Default,” a transaction counterparty may be personally liable for the entire amount due under the agreement, even if it exceeds the value of the collateral shares.
2 Liquid Stock does not provide tax or other financial, legal or regulatory advice. Tax treatment and the impacts of exercising stock options or entering into a liquidity transaction may vary, are specific to individual counterparties and transactions, and no tax result is guaranteed. Individuals considering exercising stock options or entering into a Liquid Stock transaction, should always consult with a tax advisor.
This blog post is intended for general informational and education purposes only. Liquid Capital Management, LLC (together with its affiliates, “Liquid Stock”) makes no representations as to the accuracy of information in this post, and no representations or guarantees as to specific outcomes from relying on this post. No content in this post is intended or should be construed as tax, investment, legal or accounting advice by Liquid Stock, or as an offer to sell or solicitation of interest to purchase any securities offered by Liquid Stock. Liquid Stock does not provide tax or other financial, legal or regulatory advice to its transaction counterparties. Always consult with your investment, tax, and legal advisors before making important financial decisions. The terms of any Liquid Stock transaction may vary. Outcomes (including financial and tax outcomes) of any transaction will depend on factors including the timing and value of any liquidity event. While reasonable steps have been taken to ensure that the information herein is accurate and up to date, no liability can be accepted for any errors or omissions. All views and information contained herein are as of the date hereof and subject to change. Views and opinions presented are those of the author. Information contained in third-party links has not been independently verified by Liquid Stock and inclusion of such links should not be interpreted as an endorsement or confirmation of the content therein. Prospective investors considering an investment in a Liquid Stock fund should not consider this content as fund marketing material.
