Equity Without Access: The Growing Challenge of Liquidity in Private Companies

Liquidity—or the ability to convert equity into cash is a crucial part of equity compensation. It’s great to own equity within a company worth X amount of dollars, but without the ability to liquify these shares, what do your employees really have other than a promise?

For public companies, liquidity is much easier to come by when compared to their private company counterparts and for private company employees, the challenges they experience in relation to liquifying their equity, has become much more pronounced than in times past due to more and more private companies staying private longer.

This has delayed liquidity events that employees have typically relied on to unlock the value of their equity compensation, and understanding these challenges and the potential solutions available are essential for both employees and those that manage their company’s equity programs.

The Trend: Why Are Private Companies Staying Private Longer?

In recent years, driven by a combination of economic and market factors, the trend of private companies delaying their initial public offerings has become increasingly  common. Traditionally, going public was viewed as the gold standard of success and a vital step for private companies looking to unlock substantial levels of capital. However, the landscape has shifted significantly.

The IPO market has encountered challenges, particularly in the wake of soaring inflation and rising interest rates which began around 2022. These factors have contributed to the dampening of investor appetite for high-risk ventures, leading to a decline in the tech IPO market and broader market volatility. This environment has made the process of going public not only more complex but also riskier and less financially attractive for many companies.

Additionally, the flexibility to remain private, focus on long-term growth, and maintain greater control over their strategic direction has also become an allure that many founders have found particularly attractive.

With these factors in mind, the appeal of an IPO has waned with a recent survey from TechStars indicating that only a small fraction of entrepreneurs now view an IPO as their long-term goal. Instead, many are opting to stay private longer or even seek acquisition by larger public companies, avoiding the unpredictability and short-term pressures associated with a public listing.

However, this trend of extended private status presents challenges for employees holding equity in these companies. As IPOs are delayed, the liquidity opportunities that employees might have anticipated are similarly postponed, leaving them with fewer options to convert their equity into cash.

What Challenges Do Liquidity Constraints Create for Employees?

While the challenges are many, we have listed some common examples below.

Vesting and Tax Obligations: When restricted stock units (RSUs) or restricted stock awards (RSAs) vest, they are considered income, and taxes are due immediately. In a private company, where shares cannot be easily sold, employees may struggle to raise the funds needed to cover these taxes. This can lead to financial stress and dissatisfaction with their equity compensation program.

Market Timing and Value Realization: In private companies, the value of equity is often tied up until a liquidity event, such as an IPO or acquisition. This can create a disconnect between the paper value of the shares and the actual cash employees can access. If the company’s valuation declines before a liquidity event, employees may find that their anticipated wealth is significantly reduced, leading to frustration and potential disengagement.

Employee Retention: The lack of liquidity can also affect employee retention. Employees who see their wealth growing on paper but are unable to access it may become disillusioned and more susceptible to offers from public companies where they can more easily realize the value of their compensation. This challenge is particularly acute in competitive industries, where talent is in high demand and employees have plenty of opportunities to jump ship.

Solutions to Address Liquidity Challenges

Given these challenges, what can companies do to provide liquidity options for their employees? Here are some strategies that private companies are adopting:

Align Vesting Schedules with Potential Liquidity Events: One strategy is to align the vesting of equity awards with anticipated liquidity events.

This can help ensure that employees have the opportunity to sell shares and meet their tax obligations without being caught in a liquidity crunch. However, this approach requires careful planning and foresight, as unexpected delays in a liquidity event could still leave employees in a bind due to expiration dates of their awards and the potential time horizon associated with the triggering event.

Implement Secondary Market Solutions: Secondary market platforms allow employees of private companies to sell their shares to accredited investors (if their company allows it). These platforms provide a structured way for employees to access liquidity, even if the company is not yet public.

However, companies need to carefully manage these transactions to ensure they align with corporate policies and maintain control over the cap table. Additionally, employees should be aware that secondary market transactions may be subject to discounts, meaning they might not receive the full market value for their shares.

Consider Share Withholding for Tax Payments: Another solution is for the company to implement share withholding, where employees can remit shares back to the company to cover their tax obligations. This avoids the need for a public sale, but companies must consider the cash flow implications of this approach and be prepared to cover the employees tax obligations.

NASPP Resources

It’s true the IPO market may be due anyday now for a resurgence and the challenges of liquidity may be lessened to a certain degree, but at the moment that statement may lean more towards the side of wishful thinking than a data driven hypothesis, so as admins of private companies, it’s important we prepare for the worst, but hope for the best.

We may yet be looking at a new world where the time horizon for traditional methods of liquidity may no longer be the standard and for that reason, it’s important to stay educated on current trends and in SF on October 14^th-17^th , the NASPP Annual conference is providing an opportunity for private company admins to thought share and learn from industry experts on how to maximize the potential of their private company equity programs.

We hope to see you there!