Do you have one or more shareholders yearning for liquidity? Maybe they want to buy a vacation home, or send a child to private school. If they are not active day-to-day with your company, then maybe letting them out is a good idea, for everyone. How do you solve for this? Even with an agreed price, it can be complicated. Below are several methods that private companies can use to facilitate shareholder liquidity. The upsides and downsides to employing each of these solutions are discussed.
One possible solution is to execute a company buyback; however, due to fiduciary requirements, your lawyers will likely advise that the company should make the same identical purchase offer to all shareholders. Now what? The company may not have sufficient funds to buy out one anxious shareholder, much less a whole group of them. And a partial buyback may end up with no one being happy.
You could encourage the single anxious shareholder to find another shareholder willing to buy the shares in a private sale. Between two individuals share price often becomes contentious. When and if agreement is reached, then board approval may be required. Sometimes this triggers a right of first refusal (ROFR) process which can be frustrating, expensive (legal fees), and time-consuming. Worse, if the prospective shareholder is new and relatively unknown to the company, this can exacerbate everything.
For larger stock positions (think upward of $1M or more), the seller or the company may decide to retain an investment banker or private stock broker to help find buyers. While relatively expensive, this taps into a larger network of interested buyers. If many shareholders seek substantial amounts of liquidity, then the company can run a secondary offering. Some companies elect to hold these “window” events annually or semi-annually. Due to the efforts required to place the securities, including all proper disclosure documents, secondary offering costs can run as high 5-10% (or more) of the aggregate proceeds.
The sad news is that many anxious shareholders end up being forced to stick it out, all the while advocating for the company to stop trying to grow and start looking for a corporate buyer. If the anxiety grows, it can turn into dissention. Then dissention can turn into dysfunction. Suddenly, a happy, tight-knit, successful family can’t seem to have a relaxing Thanksgiving dinner together. The next thing you know, M&A bankers are hired, the sealed bid process begins, and the family business is sold. It’s so unfortunate; but, it generated needed liquidity and saved the family.
With more and more companies staying private, and venture capitalists throwing their weight into the battle for liquidity, entrepreneurs are inventing novel approaches. In recent years we have witnessed a startling new way to raise funds: the Initial Coin Offering (ICO). Suspect for violating US securities laws, most of these programs were carried out in safe-haven international jurisdictions, and purportedly restricted to non-US investors. Since many of those ICO offerings turned out to be weak (at best), maybe this restriction was a blessing.
Nevertheless, the concept of tokenizing securities, done in a proper and compliant manner, has striking advantages as a mechanism for providing liquidity. For starters, since tokens exist on blockchains (after all, tokens are simple ledger balances), the transactions can occur at extraordinarily low cost and high efficiency. Due to the distributed nature of public blockchains (many thousands of identical nodes around the world), transactions are recorded immutably. Blockchains are an accountant’s dream come true. There is no need for expensive intermediaries like custodians, transfer agents, and auditors. Importantly, these same advantages that vastly streamline fund-raising for new issues are just as applicable for the secondary market of private securities.
These advantages can be recognized by the implementation of a dedicated trading platform, or secondary marketplace, for an individual company. Within your company’s walled garden, shareholders can sell their shares in a private, secure, and trustworthy environment. Furthermore, they will be able to sell only to purchasers that you authorize, and only within price limits that you approve, all with the help of blockchain technology. There are many upsides of employing a trading platform for buying and selling your company’s shares, notably the quick stand-up time and ease of use for shareholders. Most importantly, as the owner of the company, complete control of all aspects of the platform reside with you, the trustee, and company-appointed administrators.