Private Market Liquidity: Exploring Paths and Strategies for Today's Companies

An initial public offering (“IPO”) has long been regarded as a key milestone and important liquidity event in the life of a venture-backed private company. In recent years, however, more private companies have been delaying their entry into the public markets, which has presented new equity and liquidity challenges for them to navigate.

The Uncertain Path to IPO

Traditionally, private companies went public via IPO either when they reached the threshold of allowable shareholders on their capitalization table, or with the strategic goal of:

• Raising primary capital from public market investors
• Rewarding existing investors and employees with liquidity
• Increasing brand awareness and strengthening their market position in the eyes of potential customers

In the past decade, two major developments have happened within the private markets that have made the route to IPO more complex. First, The JOBS Act of 2012 increased the allowable shareholder limit from 500 to 2,000 shareholders. Second, there has been an influx of capital into the private markets from institutional and individual investors. The combination of both developments has given late-stage companies the ability to continue raising capital long past when they would traditionally have gone public. As a result, the average timeframe for when a startup launches to when it goes public has extended to now over 12 years¹.

Furthermore, the high listing costs and greater scrutiny that comes from being a public company, has led many leaders to explore alternative paths to the traditional IPO.

Increased Pressure for Shareholder Liquidity

In today’s competitive talent market, equity compensation is a powerful tool that private companies often rely on to attract and retain employees. A strong equity program not only rewards employees but can also create a deeper culture of ownership within the organization. If an employee understands the value potential of their equity awards as the company grows, there is a collective incentive to work towards common company goals.

But what happens to the perceived value equity when companies are choosing to stay private longer? A delayed IPO can potentially lead to liquidity pressure building up among a company’s participants.

While liquidity may be a strategic priority for some companies, the private markets don’t have the same level of regulation and infrastructure for buying and selling stock that the public markets have. Furthermore, the objectives and time horizons of public and private market investors can vary significantly. Private companies tend to want long-term, value-add investors on their cap table that will be able to support multi-year growth of the business.

In summary: private companies are facing a two-sided challenge: pressure for shareholder liquidity introduced by an extended timeline to IPO, and the need for a trading infrastructure and transaction execution framework that caters to private markets.

The Rise of Company-Sponsored Liquidity Events

Companies staying private are increasingly turning to secondary offerings (i.e. tender offers) to support shareholder liquidity. The benefits of a tender offer are two-fold: eligible shareholders can access partial or full liquidity for their vested equity while companies maintain control over who can participate and how much equity can be sold. By leveraging this transaction structure, companies can potentially mitigate dilution and control who is on their cap table.

Of course, managing a tender offer and integrating it seamlessly into an existing equity program requires considerable groundwork and planning. Companies must consider transaction mechanics such as participant eligibility, pricing, timing of the transaction, as well as the legal and financial disclosures that need to be provided to transaction participants. For employees that haven’t participated before, companies also may need to help them understand the financial and tax implications of a tender offer and help understand how to manage the financial needs and goals.

A tender offer can have a significant impact on a company’s equity compensation program, which is why it’s important to partner with a strong equity provider as well as tax and legal counsel. However, as companies stay private longer, facilitating recurring liquidity events can be a powerful way to enhance their existing stock plan benefits while mitigating some of the pressure to go public within a certain period of time.

Staying Transaction Ready in Uncertain Times

Market volatility has the potential to further complicate a private company’s path to liquidity. Companies pursuing an IPO may have to consider the extent to which uncertainty public market conditions can impact the timing of their debut a critical success factor. For companies considering offering liquidity to its shareholders, private market volatility can contribute to a widening gap in valuation from prior fundraisings round and what secondary market investors are willing to pay. This may force companies to make a difficult decision delaying an organized liquidity event, conduct the transaction at potentially a lower share price, or allowing shareholders to sell openly on secondary exchanges.

While market conditions remain uncertain, companies can control the degree to which they are “transaction ready.” Transaction readiness is a discipline more companies are adopting as a way of keeping their equity plans and operations organized in the event of a large liquidity transaction, M&A, or IPO.

Staying transaction ready will require companies to continually connect the dots between their investor community, board of directors, and employee base before making a liquidity decision.