Private Market Liquidity: Exploring Paths and Strategies for Today's Companies

The initial public offering (“IPO”) has long been regarded as a key milestone and important liquidity event for private companies. Yet, as more firms delay their public market offerings in recent years, this has presented a challenging new landscape to navigate for equity and liquidity management.

For private companies looking to enhance the benefits of their equity compensation plans, Morgan Stanley at Work offers liquidity solutions.

The Uncertain Path to IPO

Traditionally, private companies went public via IPO either when they reached the threshold of allowable shareholders on their capitalization table, or with the strategic goal of:

• Raising primary capital from public market investors
• Rewarding existing investors and employees with liquidity
• Increasing brand awareness and strengthening their market position in the eyes of potential customers

In the past decade, two major developments within the private markets have made the route to IPO more complex. Firstly, the Jumpstart Our Business Startup Act (JOBS Act) of 2012 raised the allowable shareholder limit from 500 to 2,000 shareholders enabling companies to stay private longer. Concurrently, the private funding environment transformed with unprecedented⁴ amounts of venture and late-stage funding flowing into private markets, allowing companies to raise large sums without IPOs. The combination of both developments has given late-stage companies the ability to continue raising capital long past when they would traditionally have gone public. As a result, the average timeframe for when a startup launches to when it goes public has extended to now over 12 years¹.

The significant expenses and rigorous oversight associated with going public have led some leaders to explore alternatives to a conventional IPO.

Increased Pressure for Shareholder Liquidity

In today’s competitive talent market, private companies often rely on equity compensation as a powerful tool to attract and retain employees. A robust equity program not only rewards employees, but can also, create a deeper ownership culture within an organization. When employees understand the value potential of their equity awards as the company grows, everyone can share a unified vision for long-term success.

But what happens to the perceived value equity when companies are choosing to stay private longer? A delayed IPO can potentially lead to liquidity pressure building up among a company’s participants.

While liquidity may be a strategic priority for some companies, the private markets do not have the same level of regulation and infrastructure for buying and selling stock that the public markets have. Furthermore, the objectives and time horizons of public and private market investors can vary significantly. Private companies tend to want long-term, strategic investors on their equity cap table that will be able to support multi-year growth of the business.

In summary: private companies are face a two-fold challenge: satisfying demands for early shareholder liquidity, and the need for a trading infrastructure and transaction execution framework that caters to private markets.

The Rise of Company-Sponsored Liquidity Events

Companies staying private are increasingly⁵ turning to secondary offerings (i.e., tender offers) to support shareholder liquidity. The benefits of a tender offer are two-fold: eligible shareholders can access partial or full liquidity for their vested equity while companies maintain control over who can participate and how much equity can be sold. By leveraging this transaction structure, companies can potentially mitigate dilution and control who is on their cap table.

Managing a tender offer requires considerable groundwork and planning to fit smoothly into your current equity program. Companies consider transaction mechanics such as participant eligibility, pricing, timing of the transaction, and the legal and financial disclosures to be provided to transaction participants. For first-time participants, companies may educate employees on financial and tax implications of a tender offer.

A tender offer can have a significant impact on a company’s equity compensation program, which is why it can be important to partner with a strong equity provider, tax advisor and legal counsel. As companies stay private longer, facilitating recurring liquidity events can be a powerful mechanism to enhance their existing stock plan benefits while mitigating some of the pressure to go public within a certain period of time.

Staying Transaction Ready in Uncertain Times

Market volatility has the potential to further complicate a private company’s path to liquidity. Companies pursuing an IPO may have to consider the extent to which uncertain public market conditions can impact the timing of their debut. For companies considering offering liquidity to their shareholders, private market volatility can contribute to a widening gap in valuation from prior fundraisings round and what secondary market investors are willing to pay. This may force companies to make a difficult decision delaying an organized liquidity event, conducting the transaction at potentially a lower share price, or allowing shareholders to sell openly on secondary exchanges.

While market conditions are uncertain, companies can control the degree to which they are “transaction ready.” Transaction readiness is a discipline some companies are adopting as a way of keeping their equity plans and operations organized in the event of a large liquidity transaction, M&A, or IPO.

Staying transaction ready requires companies to continually align their investors, board of directors, and employees before making a liquidity decision.