Why Companies Are Embracing Employee Liquidity
In recent years, the average technology startup took between eight and ten years to go public. That’s a sharp increase from the five to eight years it took for a technology startup to go from conception to IPO in the 80s and 90s. A number of factors have contributed to this change, including easy access to capital, the cost and distractions of going public, and changes in regulations.
Staying private has many advantages. It allows high-growth companies to mature and avoid the short-term pressures and scrutiny public companies face. But remaining private isn’t painless, and the longer a company does so, the more likely it is to face misalignments among stakeholders.
As a company grows, its founders, executives, current employees, former employees, and early investors all see their paper wealth accumulate. But stock options and other forms of illiquid private company equity can’t help them put their kids through college or pay for a new home. As life circumstances change, it becomes increasingly hard for employees to stay focused on work.
This leaves employees, a startup’s biggest assets, vulnerable to poaching — especially by the so-called FAANGs (Facebook, Amazon, Apple, Netflix and Google). They tempt employees away with offers of signing bonuses, bigger salaries, and more valuable equity.
Time to IPO
Meanwhile, long-time workers and former employees are saddled with options that expire after 10 years under federal law. Even if they could exercise their shares, they may not have the cash to do so or to pay the resulting taxes, which grow more onerous as the company’s 409A valuation rises.
These pressures could entice employees, and even executives, to contemplate selling their shares on the open market. While most companies have explicitly banned such sales, shares from former employees, service providers, and junior preferred investors still show up at online brokers. Having an unknown broker at the cap table is not a situation most executives look forward to.
Company executives are not blind to these struggles, but loosening the reins on secondary sales comes with its own challenges, such as investors losing control and the company’s 409A valuation taking a hit. Other attempts to be helpful (like facilitating cashless exercise, giving bonuses, RSUs, or new option grants) also come with unique downsides.
Why companies are staying private longer
Employee liquidity programs are a win for everyone
Employee liquidity programs are not about cashing out; they are about releasing just enough pressure to foster what we call “patience in the building,” or the staff’s ability to focus on their work rather than fret about financial pressures and the fate of their options. More importantly, when they’re thoughtfully crafted, they can be a win for everyone involved — employees, executives, investors, boards, and of course, the companies themselves.
….but when should companies pull the trigger for implementing a liquidity program?
It’s no surprise that there has been a steady uptick in interest in employee liquidity programs from management teams and their boards. But when is the right time to execute such a program? Founders Circle has observed that the following circumstances tend to trigger companies to facilitate an individual or broadly based liquidity program.
Triggers for companies to consider a liquidity program
Nasdaq Private Market (NPM) has identified some of the factors that trigger companies to set employee liquidity programs (and employee-wide tender offers, in particular) into motion. While tender offers are one of several employee liquidity use cases, they serve as something of a proxy for the other use cases.
Companies that conduct employee-wide tender offers tend to share these baseline characteristics:
- A significant percentage of the employee base been there between four years (1.0x of the standard vesting period) and six years (1.5x of the vesting period)
- The company has granted equity (including ISOs, NSOs, and RSUs) to at least 100 employees
The NPM has reported that nearly half of the buyers in tender offers are trusted third parties, like Founders Circle. Just over a quarter of the transaction volume relates to recurring programs, in which a growth-stage private company conducts another employee tender offer within 12 to 18 months.
Furthermore, the graphic below shows the 450+ common characteristics of liquidity programs involving more than 49,000 participants, which ran through the NPM platform since its inception in 2014.
Average traits of companies that conducted tender offers in recent years