NAVIGATING the EMPLOYEE LIQUIDITY PATH: PRIVATE vs. IPO
Free flowing private capital, strong cash generation, and a desire to avoid regulatory requirements are among the reasons companies are staying private longer—an average of 8.1 years compared to 6.8 years in 2010, according to PitchBook (PitchBook-NVCA Venture Monitor, p. 20).
The extra time out of the public spotlight gives them time to iron out the wrinkles in their business models. But it prolongs the promise of wealth by denying liquidity to the employees and investors who powered the company to a successful position.
Jeff Thomas is the Head of Listings at Nasdaq. There, he runs the Western region where he interacts with some of the largest and fastest growing private technology companies. In combination with his prior role at Nasdaq Private Market as Head of Sales, he oversaw the execution of 100+ private tender offers for a total value of more than $4b+ and 40+ IPOs with a total value in excess of $5b+.
We spoke to Jeff about the various paths his clients take to achieve liquidity for shareholders.
How do you compare the mind-sets of private companies vs. public companies?
For starters, it isn’t one type of CEO vs. another type. It’s the same person—it’s just driving the needs of the business to different points at different moments in time.
While there is no hard-coded algorithm, the continuum generally looks like this for start-ups seeking to fuel their high rate of growth:
As the Pitchbook data shows, startups are seeking to remain independent until the private markets say “it’s time.” In between, it’s a balancing act of continued access to private capital markets with fulfilling the wealth promises to employees and, eventually, investors.
Meanwhile, when you’re a private company, there is a lot to work on. You can, hypothetically, place three bets and hope that one of them hits. You have to figure-out how to compete with FANG—Facebook, Amazon, Netflix, Google—because they’re into all sectors. There are the constant trade-offs between how much you’re going to spend for growth and how much you’re going to generate in profitability. Not being cash flow-positive really affects a company’s public-market valuation. These are very real discussions for founders on the private side.
Then, as companies near the public end of the continuum, they need to be of meaningful scale with a lot more internal infrastructure and process before they’re ready for the scrutiny of institutional investors and investment analysts. They need to be ready to stand up to the rigors of quarterly earnings calls, setting good guidance and consistently beating it. They have to be able to look three quarters into the future and know exactly what’s going to close and when. So, by the time the company actually goes public, it’s really more of a branding event than a financing event.
This is why it’s would not be surprising that Nasdaq Private Market's team and Nasdaq's IPO team may both be talking to the exact same companies at the exact same time. These companies are often evaluating the tradeoffs between facilitating a private tender offer, going public, or being acquired.
Describe the current environment for private tenders vs. IPOs.
2016 was the slowest year for IPOs since 2009. There was a bid/ask spread where private companies and institutional investors couldn’t close the gap and public listings were delayed. That said, last year, Nasdaq welcomed the vast majority of the IPOs that came to the U.S. market.
Everyone thought that 2017 public listings were going to come out of the gate fast. And, to be sure, 2017 has been healthier (PitchBook-NVCA Venture Monitor, p. 19). But, historically speaking, it thus far has not been a banner year for IPOs. And, unfortunately, some of the companies that had this year’s biggest IPOs haven’t performed well in their quarterly announcements. This has cast an underlying uncertainty about the timing to go out.
For optionality, we do see that many qualified companies are also filing confidential S-1s with the SEC. This allows them to be positioned to go public but not have to actually make their registration statements public until 21 days before the start of their IPO roadshow.
Consequently, that same uncertainty is not present for private tender offers. The slower IPO pace has caused these same companies to increase their interest and execution of employee liquidity programs. When management makes the decision to hold-off on an IPO, there’s a sincere desire to then make good on their earlier messaging to employees that some liquidity would be forthcoming. In 2017, we’re seeing both an increase in the number and dollars per deal of private tenders vs. those from year. And a third of these programs are repeat programs by the same companies who had executed a program in the past 1-2 years.
Are employee-wide private tenders more popular today than one-off transactions?
First, a little framing might be helpful.
Within the context of the two use cases you cited, there are a number of factors that a company will encounter when allowing employee liquidity via selling a portion of their vested incentive stock options—shareholder inclusion, disclosure rules, 409A valuation, business tax, associated legal and compliance coverage, personal tax and wealth planning. The employee-wide tenders allow the company much greater control but much more to manage. One-offs are arm’s length with very little burden on the company, except facilitating stock transfers.
The direct secondary market was initially very institutional. Just a couple of funds were buying out the individual blocks of founders, departed employees or tired VCs. Around the advent of LinkedIn and Facebook and Twitter, one-off transactions grew dramatically and, by many accounts, created a lot of chaos for those companies.
They faced challenges around disclosure issues, impacts on 409A valuation, and the work involved with processing transactions. Consequently, you saw a lot of companies start to clamp down on these types of one-off transactions via transfer restrictions (found in company bylaws), company and investor rights of first refusal (ROFRs) and employee agreements that contained prohibitions on the pledging of shares (which pertains to loan-style transactions).
At the same time, those early “wild west” moments also spurred private tender offers where a company could put in place certain controls on employee liquidity that aligned interests between the seller, company and the board. They could define who gets to participate, limit how much each could sell, manage information disclosures, and more predictably forecast the 409A and taxation impacts.
We’ve been seeing a little bit of movement lately, the proverbial pendulum swinging back, where companies are saying, “Hey, these tenders are actually a fair amount of work themselves.” Yet, the needs of founders and employees, sometimes older investors, are not going away. Subsequently, Nasdaq Private Market is now providing solutions for companies that want to facilitate one-offs more efficiently, while still maintaining control of their process.
What information is required in a private tender?
On these programs, you generally see the equivalent of SEC Rule 701 disclosures: business descriptions, audited financials, summary cap tables. The goal of these transactions is information symmetry. You want the buyers and sellers to have access to the same information.
So if you go out and engage with investors who might ultimately be buyers, and you show them a set of projections, you’ll need to show that same set of projections to your employees who may be participating in the private tender. Companies should seek good counsel from their law firms to navigate such issues.
The buyers also need to be vigilant about what information they have that might not also be known by the company’s employees. For instance, investors will always push for projections where the company may not be keen to share this information with employees (e.g., the information list for 701 looks backward, not forwards).
How can companies be mindful of the knowledge and experience gap for employees while walking the fine line of not giving advice?
While the company wants to avoid the inherent liability associated with dispensing legal and financial advice around employee’s decision to sell some of their vested options, it does want its employees to make informed decisions so they can ultimately experience a wealth creation moment.
Subsequently, we see most companies bringing in third-party accountants, financial advisers, even lawyers to help employees understand their tax obligations, which can be significant, and how to start managing their new found wealth. This may be the first significant amount of money that some employees have in their life, and they may want to be thoughtful about whether to buy a sports car or start saving for retirement. If they’re lucky, they’re in a position to do both. Nasdaq Private Market has a partnership with Morgan Stanley Private Wealth if companies want to make this kind of resource available to their employees as part of the private tender offer.
If during the private tender process, a company is sending out a thick set of paper documents to employees and asking them to fill them out by hand, there’s a high degree of likelihood that mistakes will happen. The company’s CFO or general counsel ends up managing a spreadsheet, dealing with a bunch of paperwork being filled out incorrectly, and trying to manage dozens, if not hundreds, of individual payments to participants on the back end. Because CFO’s & GC’s have experienced the administrative pain of managing these transactions, they find that Nasdaq’s Private Market platform eliminates the friction.
What takeaways or parting advice would you offer a founder who’s trying to manage the process?
It’s about providing liquidity. Private or public are merely different paths of getting to the same objective at different time stamps. What’s important for Founders & CEOs to know is that there are strategies for them to choose from along that continuum.
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