Ultimate Guide on Selling Stocks in a Private Company
In this article, we will discuss ways to sell shares of a private company.
Selling stocks of privately held companies can be complicated and restricted at the same time. As private companies are usually small and not listed on the stock exchange, their shares are not easily transferable. In this regard, stocks or shares refer to a portion of the company’s ownership. Likewise, the shares of private companies usually have a limited number of shareholders whose ownership and withdrawal are highly restricted. But, did you know that selling shares of private companies is possible? In this article, we will discuss ways to sell shares of a private company.
Stock selling in private companies
Privately held companies generally have a limited number of shareholders due to the fact that the shares are not readily traded. This means that the shares cannot be bought and sold in the stock market or exchange, which gives the company strategic control over its ownership. That being said, the sale of shares can be made under certain conditions and in a set manner. Selling stock in a private company is highly restricted and limited because the company’s ownership is confined to a few people.
What are stock/shares in private companies?
A stock or a share refers to a certain portion of ownership in a company. In early-stage companies or startups, the ownership is held by a small group of individuals usually equity investors, employees, and founders. During the fundraising process, equity or shares are issued to investors in return for the money they put into the company. Additionally, stock-based compensation is a way to compensate and encourage employees in private companies by granting shares.
What is private placement?
Unlike public companies, private companies are not listed on the stock exchange and thus they do not have a public float. A private placement is a method by which private companies sell their shares to pre-selected accredited investors, institutions, and other related parties. Private placements are usually exempted from registration with the Securities and Exchange Commission (SEC). With the help of private placement, shares can be sold and capital can be raised for the company.
In addition, private placements are seen as a way for companies to raise capital without going through the complete process of making a private company into a publicly traded company. As a result, private placements are useful for companies that want to raise capital but still want to avoid the hassle of a public listing.
How does stock in private companies work?
Keeping in mind that private companies are different because they have no public listing, shareholding in a private company is concentrated among a few people who are usually the shareholders and employees. In privately held companies, shares are issued in return for investment, shares issued under equity compensation for employees, advisory shares to advisors, and other similar forms of interest. In this way, stock in a private company can be used to raise the amount of capital that needs to be raised and at the same time, it is a way to motivate and compensate employees. But, why sell stock in private companies?
Why should private companies sell their stock/shares?
Selling stock in a private company is typically complicated, however, it can be beneficial because it can attract strategic investors, advisors, employees, and other parties to invest in the company. Private companies generally have limited cash and resources because they are small in size and thus, financial support is required for them so that the company can grow. In this case, selling stock can be used as a means of raising capital and attracting new investors to the company. Likewise, it is also a way to retain employees and motivate stakeholders by offering them incentives in the form of shares. Therefore, privately held companies can sell stocks to gain access to necessary resources, attract strategic partners, and retain employees.
Accredited vs Non-accredited Investors
Before we discuss the methods you can use to sell stock in a private company, it is important to understand accredited and non-accredited investors. Accredited investors are defined as investors who meet certain qualifications and are approved by SEC to invest in private companies. It is important to note that in order for an individual to be an accredited investor, the individual must have the financial capability to bear risks associated with investments.
The SEC defines the net worth and income standards for determining accredited investor status as income over $200,000 or individuals working in the financial industry. On the other hand, non-accredited investors are investors who do not meet the criteria set by the SEC. They may include individuals who are investors. However, they fail to meet the income and net worth standards. Hence, non-accredited investors can include family members and friends who are interested in investing in the company.
Difference between private placement and public offering
In a private placement, securities are sold in an offering to qualified investors, who range from institutions to a select number of individuals with high net worth and income. On the other hand, in a public offering, securities are sold on the stock exchange and investors can be the general public. The following are a few more differences between a private placement and a public offering:
- Under the private placement, the company can sell shares and still remain privately held. This means that the company does not have to register with the SEC and, there is a legal requirement for information to be disclosed. In comparison, a company that issues shares on a public exchange must register with the SEC and file IPO or Initial Public Offering. After the IPO, the company becomes publicly owned and the shares are no longer held within the company.
- The shares are not easily or freely traded with private placements due to the fact that shares are not listed on the stock exchange, and thus shares are issued with a specific intention. On the other hand, in an IPO or a public offering, the shares are freely traded and stock can be bought and sold by anyone, including the general public. As a result, the liquidity with private placements is less when it comes to buying and selling stock compared to public offerings.
- The dilution of shares with private placements is limited to the number of shares issued and the investors or employees who are participating in the private placement. It is important to note that when a company issues shares under a private placement, they have full control over the number of shares issued. In contrast, in a public offering, the level of dilution is high because all the shares issued are publicly held and readily available to be traded.
Types of selling stock in private companies
Now that we have understood the basic concepts of shares and private companies, here are some of the most commonly used ways for selling stock in a private company:
- Going public – When a company decides to go public, they choose to register with the SEC, file for an IPO, and list its stock on the stock exchange. The main goal of going public is for a company to raise much-needed capital and get large investors to invest in the company. This method is beneficial for companies with long-term goals that can help the company grow and expand.
- Large private investors – One of the simplest and easiest ways to sell shares in a private company is through large private investors. The main advantage of selling shares to large private investors is that it does not require additional regulatory compliance or filing with the SEC. They can be accelerators, angels, or venture capitalists who invest in the company.
- Small investors – Another option is to sell shares to small investors. Small investors are generally individual investors as well as institutional investors. They are considered individuals who invest small amounts of money and can help to fuel the company’s growth. As a result, this can provide the company with additional capital.
- Employees – Stock-based compensation is an effective tool that can be used to motivate and retain employees. Generally, stock options are offered to employees wherein they are given the opportunity to buy stocks in the future at a fixed price. ESOP, for instance, is a way to sell shares to employees by allowing them to buy company shares at a given price.
How does selling stock in private companies work?
The process of selling stock in a private company works in a variety of ways. However, it is a complicated process and involves many considerations. With private placements, tender offers, equity compensation, and going public, there are many factors that come into play. It may feel overwhelming because, no matter the method, there are always concerns about financial obligations and risks associated with the process. That being said, it is essential for private companies to carefully plan, organize, and be thorough in the process of selling shares.
Best time to sell a private company’s stock
There are some situations that might indicate when it is best to sell stock in a private company. These scenarios include the following:
- Raise funding – If a private company is looking to raise capital for expansion and growth, it might be best to sell shares. The goal would be to get the right investors with the right expertise and with the required capital and in turn, the company must issue shares at a reasonable price.
- Hit the price target – 409A valuation is used to measure the fair market value of the common stock. As such, when the price target is reached and it is the right time for a company to sell its stock, then the company must look out for the best way to sell the shares of the company.
- Better opportunity comes along – It is important for a private company to always have an eye on new opportunities when it comes to business. The opportunity cost of waiting for the right time to sell stock serves as one of the main reasons why a company should sell its stock when a better opportunity comes along.
- After bankruptcy – Once a company is in bankruptcy, it is sometimes best to sell the company’s stock so as to liquidate shares in order to collect funds and pay back creditors. The financial situation of the company must be carefully considered and weighed in order to determine the right time to sell the stock.
- After merger – For a private company, there is always a possibility that it may be bought out by another company. Accordingly, when a merger takes place, there can be times when it is best to sell stock in order to gain the maximum value for the company and its shareholders.
- Deterioration in fundamentals – A company with low profitability, poor management, loss of market share, and minimal growth prospects would not have a bright future. When these issues become apparent, it can be best to sell the company’s stock in order to avoid further loss.
How to sell private company’s stock?
When it comes to selling a private company stock, there are a number of options. For example, there might be a situation where there is an internal reorganization or an acquisition of another company. In that case, IPO or public stock offering might be the best solution. Additionally, when a private company requires funds for expansion and thus, in that case, one of the options for selling stock would be a private placement. As a result, there are several options for selling stock but it is important to weigh all the options carefully.
Special consideration for selling stock in private companies
You might be wondering what considerations should be made in order for the private company’s stock to be sold. There are two main aspects that must be considered:
- Pre-IPO Private Stock – When there is an intention of going public, then it might be best to consider pre-IPO private stock. Venture capital markets for the public are essentially pre-IPO private firm stock exchanges. A pre-IPO private company employee who owns equity may sell shares on such an exchange. To purchase pre-IPO stock, some secondary market websites provide financing.
- Non-pre-IPO Private Stock – In case of the company no considering an IPO, then it might be a good idea to look into the non-pre-IPO private stock. Investors may sell their shares back to the issuing firm through the repurchase schemes offered by some private companies. An insider might also be able to give leads to present or potential investors who have shown an interest in purchasing the company’s shares.
Tips for selling stock in private companies
For selling a private company’s stock, here are five tips to sell stock to investors:
- Determine business value – The value of any business is an important factor to take into consideration when it comes to selling stock. As such, the business valuation must be conducted in an informed and thoughtful manner.
- Forecast future – It’s crucial to realize and understand what the future may hold for a private company’s stock. Accordingly, when considering selling the stock, it is essential to have a vision or forecast of what is yet to come.
- Determine shareholders’ needs – One of the important factors to consider when it comes to selling stock is shareholders’ needs. As such, when considering selling the private company’s stock, it is essential to know what concerns the investors.
- Create completing marketing strategy – The private company must know how to create a marketing strategy for selling shares. As a result, the marketing strategy should be aimed at informing investors and thus, the groundwork for selling the stock should be laid.
- Get business in order – By getting the private company’s business in order, it will be much easier to sell its stock when the right time comes. The business should always be one step ahead of the competition and thus, when looking into selling the company’s stock, the company must be careful with every business aspect.
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