WHEN SELLING UNLISTED SHARES IS A GOOD ALTERNATIVE
Why Sell?
To get a return on investment, private (unlisted) company shareholders may want to sell shares now instead of waiting until a 'possible' later time when the company will be acquired or go public in an initial public offering (IPO). Given the length of time to an exit event can (and often is) longer than originally slated, selling private shares in a pre-exit scenario can be a viable alternative.
Motivations to achieve pre-acquisition and pre-IPO liquidity on investments can vary. For instance, venture capital companies may want to return cash to partners, reinvest proceeds in other investment vehicles or simply depart from a company given disagreements on the direction the company should take or simply if there is a need for a new investor with different competence in light of the company's evolution. Founders and employees, on the other hand, may have a need for liquidity given personal circumstances (e.g. purchasing a family home, retirement), a desire to diversify, tax mitigation or if the shareholder does not agree with the direction of the company. Finally, the company itself may want to support such a process in order to promote talent recruitment and retention or to otherwise promote the consolidation of a large number of shareholders or even to further the replacement of one venture capital (VC) investor with another better fitting VC.
Two Common Transaction Types
Such pre-exit sales of private shares can be fully paid for upfront or can be designed to pay a portion upfront while providing upside sharing if there is an exit event and the shares are acquired beyond a certain pre-agreed target price. The latter is a great alternative for shareholders desiring to obtain some liquidity now yet continue having a stake in the company's potential exit event down the line.
Some Considerations
☐ A key issue will be whether or not the transfer of shares is permitted. The answer to such question can be found in corporate documents (e.g. bylaws, articles or shareholders agreements) and may be influenced by local law.
☐ Assuming the shares can be transferred, the next issue will be to determine whether the company is prepared to meet with the potential acquirer of the shares. The value of the shares will generally increase as the information available to a potential buyer increases. Bear in mind that the sale of such shares does not have a direct economic benefit for the company per se; however, a more qualified and more liquid incoming investor does naturally have perks for the company. Companies may express concerns about asymmetrical information situations (i.e. where an incoming buyer if meeting the company could obtain more information than the selling shareholder or even other shareholders at the company). As such, companies may, at times, elect to produce information packets that are available for distribution to potential buyers. With this said, companies may want to receive a written request from a selling shareholder (identifying the potential buyer) and have the potential buyer sign a non-disclosure agreement.
☐ Companies may want to ensure that incoming investors will be a complement as opposed to an impediment of future development. Furthermore, the potentially incoming investors may similarly want to ensure, even if legally permitted to acquire the shares, that the existing company management and major shareholders will welcome such change of shareholder(s).
☐ Rights of first refusal (ROFR) will naturally have to be honored. As such, if there is a shareholder obligation to first offer shares to existing shareholders before executing a share transfer, the procedure for adequately doing so must be respected. With this said, the time period required for the ROFR can be waived or shortened by the party/ies having such right/s; however, any such waiver must be in writing and authorized by the appropriate persons (triple check this).
☐ Incoming shareholders will be generally required to become parties to the existing shareholders agreement. As such, with the appropriate approvals, the potential purchaser should have an opportunity to review the shareholders agreement prior to acquiring the shares. Again, an incoming shareholder, e.g. an institutional investor, may want to negotiate for certain changes to the shareholders agreement in order to enable the incoming investor to become a party to the shareholders agreement without defaulting under other existing agreements. This may or may not be feasible under the circumstances.
☐ As a final point of emphasis, any such transaction must comply with local law and all obligations to the company, board, incoming investor, and other shareholders. This is for the benefit of all involved.
What I'd like to know*
If you (whether a person or company) are holding private shares in a company with the following characteristics (and would like to pursue a sale by yourself or in combination with other shareholders)- I would like to know more about the details:
A Western European company
Minimum annual gross revenue of €5 million to €10 million (but can be much higher of course)
At break even (i.e. revenues equal to or exceeding costs) or there is a clear path to profitability within a few months
The aggregate sales amount for the shares, based upon a sensible valuation, is within the range of €1 million to €5 million
There is a reasonable prospect of exit within 3-5 years
*Disclaimer
This article should not be construed as an offer to broker, buy or sell any securities. Further, this article should not be construed as offering legal advice of any kind or creating an attorney-client relationship.