Shareholder's Playbook: What to Know About Selling Your Shares
Feb 4th, 2016
So you’re working at the pre-IPO company of your dreams….but you need some immediate liquidity. You’ve heard of platforms like EquityZen that help private company shareholders get liquidity for their shares, and you want to understand more about how the process works. Then this is the blog post for you!
It’s All About the Documents, Baby
The first step is understanding the documents related to your shares. For anyone looking to sell their shares, it is very important to understand the rights that the issuing company has with respect to those shares and what steps are necessary before the shares can be officially transferred.
Here is a short list of the most common documents you will encounter as a shareholder and what each document means (a more detailed list can be found here https://equityzen.com/blog/key-equity-documents-to-keep-on-file/):
- Stock Option Grant Agreement: This document sets out: (a) the number of options being granted to the employee, (b) the type of options (incentive stock options (ISOs) or non-qualified stock options (NSOs), (c) the exercise price, and (d) the vesting schedule for these options.
- Stock Option Plan: This is the governing document that describes the terms and conditions of your grant and is the same for each optionee. This document often contains the restrictions around selling or transferring your shares.
- Notice of Stock Option Grant: A one page document describing the material terms of the stock option grant (It is not always included).
Option Exercise and Stock Purchase Documents
- Notice of Exercise: This document is filled out when you are ready to convert vested stock options into shares of the company (a.k.a. “exercise” the options). This document represents proof that you have exercised a specific number of options and shows the exercise price.
- Stockholders Agreement: The governing document that contains the terms and conditions for owning shares in the company. Importantly, this document often contains the restrictions around selling/transferring shares in the company. The Stockholders Agreement will often set forth whether the company retains a “right of first refusal” (ROFR), the length of the ROFR period, and any other conditions that must be met before the company will permit the share transfer.
- Confirmation of Exercise: This document is often provided by the company to a shareholder once the exercise of options is complete and you are now a shareholder.
- Stock Certificate/Stock Ledger: This one might seem obvious, but the stock certificate is the document issued by the company that evidences legal ownership of shares. However, since many companies do not issue physical certificates, such companies also maintain an internal stock ledger, which lists the names of all stockholders and the number of shares owned.
- By-laws: By-laws set out the day-to-day rules for the company’s organization and governance. By-laws can be important for startup employees because many companies have started including provisions in the by-laws that can materially affect your rights as a shareholder. Such provisions include restrictions on transferring your shares and any requirements that must be met before you can do so.
Who You Gonna Call?
Now that you have all your paperwork in order, the question becomes who can help you find a buyer and guide you through the share transfer process. In recent years, several platforms (including EquityZen) have arisen to meet the needs of startup employees in need of liquidity. There are a variety of options out there from traditional brokerages to platforms like EquityZen. When considering selling your shares, it is important that the firm conducts share transfers in a manner that complies with the company’s stated policies as well as applicable securities laws. Platforms may also differ based on their minimum transaction size, the fees involved, as well as the level of service and professionalism offered.
What are the Transfer Restrictions?
One of the key questions that we help you figure out is: “What needs to happen before I can sell my shares?” By reviewing your option and share ownership paperwork, we can guide you through the steps involved in the share transfer process and manage your expectations around timing of the sale. Here are some common transfer restrictions that may be applicable to your sale:
- Right of First Refusal (ROFR): Most private companies retain a “right of first refusal” (ROFR) over shares, which means that if a shareholder seeks to sell shares to a third-party, the company has the right to buy those shares back from the seller at the same price and terms that the seller offered to the third-party. Typically, when a seller submits a Transfer Notice stating their intent to sell a certain number of shares, this starts the ROFR Period, during which the company can decide whether or not it wants to buy back the shares. Typically the ROFR period will last between 30-60 days. If the company does not respond to the request within the ROFR period, or if it states that it will “waive the ROFR,” then you can proceed with your sale. Alternatively, if the company decides to “exercise the ROFR” and buy the shares back from you, then you still get your money. It’s a win-win!
- Board Approval: In addition to a ROFR, some companies require approval from the Board of Directors before they will permit you to sell your shares to a third-party. This restriction is usually contained in the By-laws or the Stockholders Agreement, if it is required by your company. Transfers requiring Board approval will often take a longer to complete because Board of Directors meetings only occur once a month or once a quarter.
- Legal Opinion: Some companies will also require you to provide an independent legal opinion stating that the sale of your shares will not violate any state or federal securities laws. If you don’t have an attorney you trust, a secondary marketplace can usually provide you a referral to an attorney who can provide this opinion for you.
- Transfer Fee: Some companies may require you to pay a transfer fee at the time that you sell your shares. This requirement is usually contained in the By-laws or Stockholders Agreement.
So…What Will this Cost Me?
The total cost to complete a share transfer will depend on: (1) your company’s restrictions and (2) which secondary marketplace you use to complete the transaction. Typically, the secondary marketplace will not charge you to review your documents or list your shares for sale. If you complete a transaction through the marketplace, then the marketplace will charge you a fee based on a percentage of your sale price (usually 5%-10%). Additional costs may be incurred on account of a transfer fee charged by the company (typically between $1,000-$5,000) and a lawyer fee to prepare a legal opinion (typically between $1,000-$2,000).
To Sum it All Up
While selling private shares is more complicated than selling publicly-traded shares, it is by no means impossible. Understanding the rights and restrictions attached to your private shares will help you considerably in determining whether you can sell your shares and what price you can command. In addition, partnering with the right secondary marketplace can be an invaluable resource in securing company approval and making the share transfer process as smooth and hassle-free as possible.