Pathways to squeeze liquidity from private shares
Please note this is general information, not individualized legal or financial advice. Always consult qualified professionals for a custom strategy.
1. Secondary Market Sales
What it is
You sell some or all of your private shares to accredited investors on a secondary market platform (e.g., Forge, EquityZen), or via direct private transactions.
Key Points
Company Restrictions: Check your company’s bylaws, shareholder agreements, or investor rights agreements. Many startups have a right of first refusal (ROFR) or other contractual limitations on share transfers.
Pricing & Liquidity: The secondary market price is often at a discount to the company’s most recent financing round. The discount compensates buyers for illiquidity and uncertainty.
Accredited Investors Only: Typically, only accredited or institutional buyers can purchase these private shares in the U.S.
Lock-Up / Board Approval: Ensure you’ve satisfied any internal policies or lock-up periods, especially for founders and key executives.
2. Structured Loans / Share-Backed Financing
What it is
Borrowing against your private company equity as collateral. Lenders evaluate your company’s valuation, growth trajectory, and your ownership stake to set terms.
Key Points
Specialized Lenders: There are niche financial firms offering pre-IPO loans. Terms can vary widely; interest rates tend to be higher than for public-share margin loans.
Valuation & Collateral: You typically need a recent 409A or a credible internal valuation. The loan-to-value (LTV) ratio might be conservative (e.g. 20–40% of the shares’ assessed value).
Risk of Default: If the shares’ value falls—or if the company falters—lenders can call in the loan or seize the collateral.
Tax Considerations: Borrowed money is generally not considered taxable income, so it can be a strategic way to access liquidity without immediately triggering capital gains. However, if you ultimately liquidate the shares to repay the loan, that will trigger taxes on any gain.
3. Company-Sponsored Liquidity Programs
What it is
Some startups organize or facilitate liquidity events for founders and employees—often called tender offers or buybacks.
Key Points
Tender Offer: The company allows certain shareholders to sell a portion of their shares at a set price. This can be financed by the company’s balance sheet or new/existing investors.
Investor-Led: If a new investor wants to increase their stake, they may conduct a secondary transaction to buy existing shares directly from founders or employees.
Less Paperwork: Because it’s organized by the company, the process can be more straightforward than a purely private deal.
Restrictions: The company may limit who can sell (e.g., only employees who have been there a certain duration) or how much you can sell (e.g., only 10–20% of your total holdings).
4. Partial Exit in a New Financing Round
What it is
During a new round of venture capital or growth equity financing, you (the founder) negotiate to sell a portion of your personal stake as part of the deal—often referred to as “founder liquidity.”
Key Points
Consent & Control: You’ll need buy-in from existing investors and the board. Some investors are more open to founder liquidity once the company has hit certain milestones or growth metrics.
Negotiated Terms: The price per share might match the new financing round’s valuation, or be at a slight discount.
Signaling: Selling too large a stake can send negative signals about founder confidence. Partial liquidity is more common (e.g., 5–15% of your holdings).
Tax Implications: This is a direct sale of stock, so you’ll realize capital gains on any amount above your cost basis.
5. Pre-IPO “Cashless” Option Exercise
What it is
If you have options (rather than already-exercised shares), you could do a “cashless exercise” in tandem with a secondary sale. Essentially, you exercise options and immediately sell the resulting shares to a buyer, covering the exercise cost and taxes from the proceeds.
Key Points
AMT / Ordinary Income: Depending on whether your options are ISOs or NSOs, there may be significant tax obligations upon exercise, so plan carefully.
Coordination: This typically happens during a major liquidity event (like a tender offer or a secondary sale) when there’s a guaranteed buyer lined up.
Valuation: The exercise price is typically the 409A fair market value at grant, but the actual sale price might be higher if the company’s valuation has grown significantly.
6. Trust & Estate Planning to Reduce Tax on Future Liquidity
What it is
Transferring private shares into a trust (e.g., Grantor Retained Annuity Trust, Intentionally Defective Grantor Trust, etc.) before they appreciate further, with the goal of reducing estate and gift taxes and potentially deferring certain gains.
Key Points
Early Action: The earlier you transfer shares (when valuation is relatively low), the more you can minimize future taxable events or estate/gift taxes on later appreciation.
Control & Voting: Structuring these transfers properly ensures you can still retain necessary control or voting rights as founder while accomplishing tax or estate objectives.
Complexity: Requires specialized legal and tax counsel. Compliance with IRS rules (e.g., 409A valuations, gift tax filings) is critical.
No Immediate Liquidity: Trusts don’t magically convert illiquid shares into cash. Rather, they optimize your tax posture so when a liquidity event occurs, the tax impact can be reduced or deferred.
Tax Considerations Overall
Capital Gains: In the U.S., the difference between your cost basis and the sale price is taxed (federal + state). Holding shares for over 1 year qualifies for long-term capital gains at a lower federal rate—but in California, you still pay that gain as regular income on the state level.
AMT (Alternative Minimum Tax): If you have incentive stock options (ISOs), exercising them can trigger AMT. Carefully plan with a tax advisor.
Gift & Estate Taxes: Federal estate and gift taxes can apply if you transfer shares to family members or trusts. Advanced planning is key.
QSBS (Qualified Small Business Stock): If your shares meet certain criteria (e.g., Section 1202 for QSBS), you might exclude up to $10 million (or 10x basis, whichever is larger) of gains from federal taxes. Must hold at least five years, and the company must meet eligibility requirements.
Practical Steps
Check Legal Agreements: Founders often have contractual obligations limiting share transfers. Know your vesting status, lock-ups, ROFR, co-sale rights, etc.
Obtain a Fair Valuation: You might need a formal 409A or external appraisal for any secondary transaction, trust transfer, or loan collateral arrangement.
Build a Transaction Team: This might include a corporate attorney, a tax advisor (CPA), a wealth manager, and possibly a specialized lender or secondary market broker.
Estimate Your Tax Exposure: Model out scenarios (partial sale vs. loan vs. tender offer, etc.). Understand how each choice impacts your near- and long-term finances.
Timeline & Negotiation: Secondary sales or trust setups can be time-consuming. Start discussions early so you’re not rushed into unfavorable terms.
Consider Strategic vs. Lifestyle Liquidity: Taking money off the table can reduce your personal financial stress and diversify risk—but also weigh the opportunity cost if you expect the company’s value to keep rising.
Bottom Line
Secondary Sales: Straightforward way to convert shares to cash but often at a discount and subject to company/board approval.
Share-Backed Loans: Provide liquidity without immediately incurring capital gains, but come with higher interest rates, collateral risk, and complexity.
Company-Led Liquidity: Potentially simpler, but availability, pricing, and share-sale limits are controlled by the company.
Trust & Estate Planning: Great for reducing long-term taxes, especially if done before shares appreciate further, but it doesn’t by itself generate immediate cash.
Tax & Legal Guidance: Absolutely essential. Mistakes or oversights can be expensive—or even jeopardize your ownership.
