Transferring Shares in a private company
Keep reading to know all about private company stocks and how to sell private company stock.
Transfer of shares in a private company is very different from the transfer of shares in a public company. In fact, there are a lot of differences when it comes to public and private stock ownership in a company and there are a lot of hurdles that come in the way as well. So, how can a person sell the share of a private company?
Keep reading to know all about private company stocks and how to sell private company stock.
Transferring shares in a Private Company
The transfer of shares in a private company is a process which should be dealt with carefully, as the devil is in the details, so to speak. Not only is the timing important, but also the price in which you transfer the shares will have tax effects later on in a private company.
What is a private company?
Let us begin by understanding what a private company is. A private company is a firm held under private ownership. The private company can obviously issue stock and have shareholders. But the shares of the private company do not trade on the public exchanges and are not issued via an IPO (Initial public offering). Due to this, there is no need for private companies to meet the SEC’s strict filing requirements for the public companies.
Types of Private Companies
There are three main kinds of private companies. Each has been explained below:
- Sole Proprietorship: In this company, the ownership of the business is in one person’s hands. In fact, a sole proprietorship is not its own legal entity. This means that all the company’s financial obligations, liabilities, and assets fall into the individual owner’s hands. And even though this offers the individual complete control over decisions, it also puts them at risk and makes it tough to raise funding.
- Limited Liability Companies (LLCs): The next type of private company is an LLC. They can have several owners and the owners are not liable for the business losses or debts. This structure was formed by merging the benefits of corporations and partnerships. And these benefits include limited liability without the need to incorporate and the pass-through income taxation benefit.
- C corporations & S corporations: These two are a lot similar to the public companies with shareholders. Nonetheless, these companies stay private and do not have to submit annual financial reports. C corporations can have an unlimited number of shareholders and are subject to double taxation. On the other hand, S corporations cannot have more than 100 shareholders and are not taxed on their profits.
Advantages of Private Companies
Undertaking an IPO is not cheap, which is one of the main reasons why small companies choose to stay private. Public companies need more disclosure, have to give out many public financial statements and do a lot of filings. Due to this, many companies tend to stay private. Another reason why companies stay private is to maintain family ownership.
Moreover, a private company does not have to answer to its public shareholders. They also do not have to choose different members for the board of directors. The final step for a private company is to go public. And going public takes a lot of time and costs a lot of money. There are multiple fees like the stock exchange listing fee, the Financial Industry Regulatory Authority (FINRA) filing fee, and many more. So, it just makes sense to stay private.
Private Company Stocks
With this said, private company stocks include the shares issued by private companies to their investors, executives and employees. For instance, startups usually use equity to compensate employees during the early stage when the cash flow is limited. These programs are designed to help motivate employees by giving them a part of the company’s profit.
How do I value the shares I own in a private company?
It is not easy to value the ownership in a private company as there is no public market for the shares. So, unlike public companies that have a price per share available, private companies have to use different kinds of methods to get the value of their shares. Some of the methods for getting the value of the private company stocks include the internal rate of return (IRR), net tangible assets, discounted cash flow (DCF), comparing valuation ratios, and many more.
Let us talk about the two main types that are commonly used:
#1 Comparative Company Analysis
This is the easiest and most common kind of method used by companies. It is used to compare valuation ratios for a private company versus ratios of a comparable public company. In case you get a group of companies or a company that is almost the same size and have the same business operations, then you can take the valuation multiples and use it. These multiples would include the price-to-earnings (P/E) ratio and then apply this ratio to the private company.
Using this method, you can do this for any kind of ratio including the operating income, revenue, book value, and so on. Some companies use many ratios to get the value of the shares and not just one as done in this example. Once they get the value, the average is taken as the approximate equity value.
#2 Discounted Cash Flow (DCF) Valuation
The next kind of method is the DCF analysis. In this method, the finances of the company undergo the time-value of money. This is done by forecasting future free cash flow (FCF) and then discounting each cash flow by a certain discount rate to calculate its present value.
Just to be clear, this process is much more complex than the comparative analysis and its implementation needs a lot more “educated guesses” and assumptions. Normally, you need to forecast the future operating cash flows, growth rates, capital expenditures (CapEx), and an appropriate discount rate. Getting the value of the private company stocks is usually done to settle the disputes between shareholders, for an inheritance, when the shareholders want to exit the business, and for many other reasons.
Note: Just know that, you need to get an outside company to help you with the valuation. There are many companies that do it. Check out more about 409a valuations here!
Selling Private Company Stock
By now you would have understood that to sell a private company stock isn’t as easy as it is for a public company. Investors and employees can sell public company shares via a broker. For selling private company stock, the shareholder will have to look for a willing buyer. And since it is not listed on any exchange, it is usually difficult.
Let us say, you are a shareholder in a company and want to sell your shares. So, you find a buyer. After that, you will have to draft and execute the Stock Purchase Agreement(SPA) between yourself and the buyer. This agreement takes into account the various restrictions that come with private company stocks. The next step is to let the company know that you want to sell your shares. This would trigger the Right of First Refusal procedure, which is a restriction placed on private company stocks.
The process can take days or even months as the company will need to go through the procedure. After that, they will decide if they want to approve the deal. There are many companies that usually do not want their company shares distributed and might reject the request to sell the shares. Moreover, some employees of the startups might feel pressured to hold onto their shares as proof of their loyalty. So, unless there is a good reason for selling private company stocks like the down payment of a house, the company might not approve of the sale.
But in case the company approves the sale, they will notify you about it. There are chances that the shares you wanted to sell can be bought by an existing shareholder in the company or the company itself. Although this should not be a trouble to you, it might be an issue for your buyer. You will need to tell them about it. If this is not the case, you can notify the buyer and have the purchase price transferred to your account.
The moment you get the purchase price, sign the share transfer form and send it along with your stock certificate to the company. Let them know that they need to transfer the ownership of the shares to the new buyer. Remember to sell all these details to the buyer as well. If required by the company, you might also have to get yourself a legal opinion about the legality of your transaction and send it to the company as well.
There are some other scenarios that can come up when you want to sell the share of a private company. They are:
Engage in share buyback program with the company issued the stock
It is the best way out where you can sell the shares back to the company. In fact, many companies usually engage in share buyback programs rather than approving the sale to an outside buyer. But there are companies that do not agree with this as well. So, if there is a program out, act fast before they close it. Also, keep in mind that getting into the program does not mean that the company will buy your shares back 100%.
Non-pre IPO sale
It is not easy to sell the stock of a company that has no intention of going public. Due to the lack of information about private companies, a lot of outside investors are usually not interested in getting the stock. They do not want to buy the stock that they know nothing about. Along with this, the company might also approve of the sale of the private company stocks to outsiders.
So, the best way out is to reach out to an issuing company and find out how the investors liquidated their shares. You can sell the shares back to the company as shared above. Connect with an insider in the company to get leads on which investors or shareholders are ready to buy the private company stocks. And like that, you can sell the stock.
Pre IPO sale
The shares of a startup company that is planning to go public with an IPO are much easier to sell. There are many web-based companies that connect investors and sellers in pre-IPO shares, such as SharesPost and EquityZen. These kinds of stock exchanges are usually ventured capital markets for the public. An employee in the company who owns the shares can list their shares for sale on this market. In fact, some of these secondary market sites offer loans to buy pre-IPO stocks.
Transferring Shares on Eqvista
Since we are talking about shares and how to transfer the share of a private company, remember that at the end of the day you need to record all the transactions that take place in a private company. The best way to record them is by using a cap table software application. Eqvista is an advanced cap table application that you can use.
It is quite easy to transfer shares on Eqvista. To do that, you need to create an account and then your company profile on Eqvista.
Step 1: From the company’s dashboard, click on “Securities” on the left side menu, and then on “equity”, which will direct you to the following page:
Here, click on the equity class from where the share transfer is about to take place. In this case, we select the option “Series A”.
Step 2: Once you do this, you will reach the next page, as below.
From here, select the certificate number of the shareholder whose shares are being transferred.
Step 3: This will take you to the page where you can see the details of this transaction. Go to the “actions’ button and click on “transfer shares”.
Step 4: You will reach the next step where you will choose the details of the share transfer, like the type, share price, and date of transfer.
There are two kinds of transfers that you can make, a partial and full transfer. Here we chose the full transfer with a share price of $30, to be transferred on November 9th, 2020.
With this, the transaction would be complete, and you will be redirected to the page of the transferor shareholder. And just like this, you can easily transfer the share of a private company through Eqvista after you sell the private company stocks.