Episode 6: The New Path From Equity to Liquidity

Aug 9, 2023

Listen as host Rodney Bolden talks with Kevin Swan, Head of Private Market Ecosystem for Morgan Stanley at Work, about private market liquidity events.

Invested at Work Podcast

Episode 6: The New Path From Equity to Liquidity


Kevin:  But I think for an employee, the most important thing is to, number one, don't be passive with your equity. Understand how it works, the things you need to be aware of regarding exercising, regarding participating in liquidity events, the tax implications, and being wise about that. But I think there's another component that is so valuable for employees just to understand how a cap table works and how liquidity preferences work and how venture capital investments work. And to understand the overall kind of value of the company, which then ultimately drives the value of your shares because of the liquidity preferences and gentle structure in these financings. Those situations sometimes could result in employees being left with nothing. To understand those things and ask those questions can be really beneficial.

Speaker 2:  You have challenges and you're looking for solutions, and that's especially true when it comes to workplace financial benefits. Your employees have their own set of life goals and trust you to help them along their financial path. What makes a difference, how you support them through inevitable economic changes. I'm Rodney Bolden, head of Industry Engagement and Learning at Morgan Stanley at Work. On this podcast, we'll talk about what we've learned and how you can provide your organization with some much appreciated clarity and education around workplace financial benefits

The path from startup to IPOs are becoming increasingly complex in the current environment. Some companies are choosing to stay private longer, creating a new set of equity and liquidity challenges. How can companies navigate the path to liquidity in today's economic climate and stay transaction ready? To help us better understand potential strategies for managing the private to public pathway. I am pleased to be joined by Kevin Swan, head of private market ecosystem at Morgan Stanley at Work. Kevin has worked with numerous companies to provide equity management and liquidity solutions. This is Invested at Work.

Rodney: Kevin, thanks for joining me today on Invested at Work. My first question for you, when thinking about private markets, you often hear the phrase, "The path to liquidity." What exactly is the path to liquidity and is it just one path or many paths?

Kevin: Yeah, thanks for having me today, Rodney. It's definitely evolved over the years. 20 years ago, especially in the late nineties when venture capital really started to mature and take off, the IPO was the ultimate liquidity event, right? In fact, it was a complete taboo across these companies to take a dollar off the table right before the company exited, either through an acquisition, but generally through an IPO. And everything was structured that way, from the equity plan to the investor structure and everything else was all positioned to have this ultimate liquidity event where everybody participates, right? Investors, employees, founders, all at the same time. And generally, that would happen within for a successful company within three to five years. But over the last 10 years, there was a lot of regulatory changes and other things in the ecosystem that changed where, all of a sudden, companies weren't IPO-ing anymore.

And a lot of the structures in these companies, from the stock option plans to the investment fund, life cycles of a VC and other things, all of a sudden, problems started arising because people needed liquidity. When you think about if you're an employee and you're in a company and you join one of these startups where you get paid way under market value, you get equity to potentially participate in that upside in the value creation. And then you're 10, 11, 12 years in and you haven't seen a dollar, but you're sitting potentially on some considerable wealth. So what we've seen over the last 10 years is a lot of different paths to use your language emerged to help solve this problem.

And I'll preface that to say it's still a little bit of the wild west and there's some really interesting stories back from 10, 15 years ago when some of these shareholders started seeking out liquidity in different ways. And it's really just continued to evolve over the past decade. And it's a problem that is being solved in certain ways, but is definitely far from being at a state of maturity in terms of kind of a de facto way to manage liquidity within private markets.

Rodney: Now, you talk about part of that was because regulations changed, but let's talk about market volatility because past three years, a lot of volatility in the market. How has that impacted the path to liquidity and liquidity solutions for private market companies?

Kevin: Our team has done a phenomenal job focusing on this at Morgan Stanley at Work where we now use a concept, transaction readiness. And we refer to it that way, because private companies today, quite often everything's planned around the IPO, right? And a lot of times when you get this pent-up demand for liquidity either from your investors or you actually have structural situations that are really hard to deal with, like an expiring option, every option plan that gets put in place generally in these companies has a 10-year expiration. And if you have employees that have been there for 10 years and all these options are expiring and there's no way to sell them, it's a big problem. And generally the approach these companies take is, "Oh, we'll IPO?" And it just solves everything.

Rodney: Right.

Kevin: And there's a number in this last cycle leading up to 2020, 2021, there's a lot of companies that were coming up against these deadlines and they were also at a stage where they were mature enough and would be successful IPOs, for example.

There's a lot of these IPOs planned by these companies in 2022 last year. And as we all know, heading out of Q1, that door got slammed shut. A lot of companies were left scrambling a bit to try to figure out what to do. So, I think that when we say transaction readiness, our approach is really about creating optionality so that a company is at a stage where they've got all their ducks in a row to use that analogy. So that whether or not that public window is open and they can go that path in IPO or whether or not they have to do some form of a company-sponsored liquidity event as a private company. They're in a position to be able to proactively approach these things in a way that can solve these challenges.

Rodney: Transaction readiness applies to the company itself, but let's talk about the employees and getting them transaction ready or helping to guide them to a path to liquidity for their options, for their equity. What are some ways in which you can help employees if the IPO doesn't happen?

Kevin: And this is a lot of the focus of our work at Morgan Stanley at Work. And the focus on the participant and bringing the education, and different planning to be able to help them understand their equity, and how to plan appropriately, but the unique thing about the private markets versus the public market, given there's no liquidity, is that the liquidity is really controlled by the company. Generally, we're talking about high-growth venture-backed companies that ultimately will IPO one day. One thing that, and really the origins in the Silicon Valley did well, is they really all are built on the same structure and same foundation. So the stock option plans all look very similar.

If they bring in an RSU plan, it looks very similar. The vesting periods are all the same. And as part of that in these companies' bylaws, especially as 10, 15 years ago, there started being a bit of the secondary activity. Companies started bringing in bylaws as well as specific terms in their employee equity plans that prevent any type of share transfers. So, for a participant, usually they can't just go out and look for liquidity on their own. So, instead, in the last really five years, the whole concept of a company-led liquidity event started coming to fruition. And the most popular way to do that is through a tender offer, which is really, it's actually quite interesting 'cause a tender offer is a public market construct.

Rodney: I was going to say, because usually when I hear tender offer, I think it's an acquisition, it's associated with the public market, but tender offer within the private market. Can you explain that a little bit?

Kevin: Yeah. The origins really came about 10, 12 years ago when some companies started thinking about how to solve this problem and started thinking about structuring liquidity events and, when given to some smart, creative lawyers, started realizing that it kind of followed the same approach and structure as a tender offer. And they basically were able to retrofit it to work within a private marketer for private securities. And it became the de facto standard over the last number of years now, where it's the most common framework that companies leverage in order to achieve these liquidity events for their employees and sometimes early investors as well.

Rodney: Is that similar to secondary market transaction with a private company or I think the other term is controlled liquidity event? Are those similar to what you were just talking about or those a little different?

Kevin: Yeah, a little bit different. So the way we think about it is kind of two buckets where you've got the issuer sponsored events, and we use event very intentionally because a tender offer is a very structured legal framework where it's actually, what a 20-business day period that it has to occur in, and it's a one-time event with a start and a finish. In addition to that, there is just a lot of general secondary transactions that happen in the market and they come in all different types of flavors, but it's more of, think of it as just an individual shareholder selling to a new investor. So, as a one-off bilateral transaction and this could occur a number of ways and through... There's now a number of brokers that emerged to do this.

We have our own secondary transaction desk at Morgan Stanley now as well. We definitely believe in Morgan Stanley at Work, is to always do it in an issuer centric way. In terms of involving the issuer, because they have certain rights, whether it's to just block the transaction, but they also generally carry the company and sometimes some of the investors as well, ROFR rights. Where any secondary transaction that's presented to the company, they have a right of first refusal to buy the shares directly.

And some companies will exercise those quite liberally. But overall, I think the message to take home here is that we see a lot of our corporate clients and some of these leading private companies start to get very proactive in managing this type of activity. So, rather than just trying to, it's kind of like a game of whack-a-mole instead of trying to just chase it down and prevent it, and just get a reign on it. To take a proactive measure either through structured events like a tender offer or things like a controlled liquidity program where basically the company says, "We will allow secondary transactions to happen, but basically on our terms." In terms of who can sell, how much you can sell, who can buy. And some companies have done a phenomenal job being very forward-thinking in how to do these types of things.

Rodney: That's what I was going to ask about recruiting and retaining and attracting talent because if I'm in that situation. I could be working for a company like you said, where I'm taking less in compensation because I know the payout will be there, but it may not, it may fail. So I would imagine, and correct me if I'm wrong, and explain it to me. That as a private market company, my retention and recruiting strategies are a little bit different when it comes to offering equity.

Kevin: Correct. And I think we've seen them evolve with the company's lifecycle, because I think in that first two, three years of a startup, it's still very similar to 20 years ago, the value proposition, the upside, you're going to take less salary. But what's changed in this market today is, with the scale and the size of these companies and the amount of capital they're able to raise. When you're recruiting employees now, you're actually competing with the large public companies, but you can compete in a different way because you don't necessarily have that same upside, because when you're one of these late stage unicorn companies, very unlikely that you can tell a new recruit that there could be 1,000 X on upside on your equity. That story exists when you're a brand new startup, pretty hard to sell that story when you're already worth billions of dollars.

And conversely, they now have the capital given the ability to raise it, to pay competitive salaries to their public counterparts, they can pay the same on the salary points. And now you get to the equity component and really for these late stage companies, like whether you're being offered a package... So consider a potential recruit who has an offer from one of these large private companies and a public company, and they're almost par offers in terms of the salary as well as the equity. Big difference, though, is if you join a public company, you've got liquidity on that equity, in a private company you don't. It's like, well, the one with liquidity's probably going to be more attractive just giving you actually have that liquidity option. And so, that's why a lot of these late stage private companies now have brought in liquidity programs so that they can also give that promise of liquidity in order to be competitive in the talent market.

Rodney: You advise a lot of companies that are looking for liquidity solutions. What are some missteps that you've seen and how do you advise them to avoid those particular missteps?

Kevin: Yeah, there's definitely a few. I think quite often what we see though is when there's a larger financing and there's a secondary component, because it's really interesting thinking through the psychology of a founder or a CEO who, in this day and age, is generally the founder thinking through how do you essentially approve or allow an early investor to take money off the table? And a lot of times the founders participate in these transactions as well, so they're taking something off the table as well. How do you as a founder and CEO do that? And then look to all your employees and the ones who have helped build your company and say, "But none of you can have it."

Rodney: But you can't.

Kevin: Exactly.

Rodney: Exactly. "You can't do it, but I'm going to take some money off the table."

Kevin: Yeah, exactly. It's a real culture killer. And there's actually been situations in the past few years where this has happened where the founders are starting to get publicly called out and employees rising up, and it's definitely something I think most companies and founders now avoid. And just realized you don't do that. So to answer your question directly though, is the way it affects employees is quite often when there's a large financing. Maybe some investors participate in a secondary component, maybe the founders do, and the executives. Is they generally then run a liquidity event, usually in the form of a tender offer in parallel with all it. So, essentially, everybody can participate in some liquidity.

Rodney: Now, I know the role of an equity plan in the public sector. Is it similar or how's it different on the private side?

Kevin: Five, six, seven years ago, the concept of a equity admin in one of these companies was pretty foreign. It was usually something done off the side of someone's desk in legal or finance. And it wasn't until we started getting some of these large companies over the past, let's say 10 years, where they started looking to hire a public company stock plan admin. And now we've seen this kind of pool of these talented private company equity administrators rise up and we see companies hiring them earlier and earlier in their life cycle. Because otherwise you got a big mask going into an IPO. But if you kind of don't have your cap table and your equity plans in order, generally, I'd say that if you do have a head of equity, it's very similar in some ways when it comes to the equity plan piece and the different plans.

Now they're not as... In these private companies, they're generally a little more of plain vanilla, like a stock option plan and generally moved to RSUs at some point. It's fairly rare to see things like ESPPs or some of these other types of flavors you'll see in the public markets, but they're also a little bit more complicated given things like expiration dates on these things and no liquidity. And then the other piece too, is a lot of these equity administrators, they obviously administer the entire cap table as well. So not just the employee equity plans. They're not full-fledged investor relations, but they're also managing investors to a certain degree in terms of their own reporting on their holdings and things like that, and up table. So they have a much broader view, whereas when the company goes public, all that stuff outside of the employee equity plan goes off to the transfer agent. They're a de facto transfer agent in a private company.

Rodney: If I'm an employee or I'm an equity plan admin or a founder, what are some key takeaways as I start to think about that ultimate liquidity event?

Kevin: Well, I think for an employee, the most important thing is to, number one, don't be passive with your equity. Understand how it works, the things you need to be aware of regarding exercising, regarding participating in liquidity events, the tax implications, and being wise about that. But I think there's another component that is so valuable for employees just to understand how a cap table works and how liquidity preferences work, and how venture capital investments work. And just understand the overall kind of value of the company, which then ultimately drives the value of your shares. To use one example, and these are unfortunate events that do occur quite often, but when you get into down cycles and markets or just a company that may be struggling a bit, sometimes there'll be new rounds of capital that come into the company, but they come with different structure and usually the form of liquidity preferences.

And what it does is basically put the preferred shareholders higher in the stack. Giving you an example, be a company that maybe potentially attracts a large investment round and you got valued at 500 million dollars. A year later, the company has burned through that capital, can't raise again. But let's say they were able to participate in an exit and they're sold for 250 million. For an employee, you might sit there and look like, "That's not great, our value's down half, my equity's going to be worth half. Too bad." But because of the liquidity preferences and potential structure in these financings, those situations sometimes could result in the employees being left with nothing. To understand those things and ask those questions can be really beneficial to make sure that you actually really understand how the company valuation and different structures are tied to what your equity is actually worth.

Rodney: Who's teaching the employees about how to read a cap table? The valuations? Is that the equity plan admin? Is that Morgan Stanley at Work? Is it a combination of both?

Kevin: And especially in the past, in most situations, unfortunately, there wasn't really anyone who owned that. HR would sometimes field some questions. Sometimes you would get some founders that were very aware of it and would be very open and transparent with the company around those types of things. But what we see today across our clients is usually it is the equity admin now that that falls on, quite often in partnership with finance. That's one of the other unique things in private companies, is the equity admin usually doesn't sit in HR where they usually do in public companies, they're usually in finance or sometimes even legal. But what we've seen is the equity admins in our clients. We've seen them really take this on. And at Morgan Stanley at Work, we're here to support that, both the education in terms of how does it tender off work, but then also tied in to the fact that you're now on this wealth journey that you've never had to deal with before.

And what do I do with that? I have no problem sharing myself personally. I didn't have a... Because I grew up in startup world and in venture, I didn't put my first dollar into a retirement plan until I was, like in my late thirties, because all I had was all this startup equity and who knew what would happen to it. And let's laugh about it I guess, especially given my current role. I think a lot of the employees in these startups it's the same thing. You're not putting a bunch of money away every year generally, and then all of a sudden you hit one of these liquidity events in equity and now you've got some actual capital and you have to plan accordingly. We really partner with our companies and our equity admins to be able to be there to help the employees on that journey.

Rodney: Kevin, I can tell you have a real passion for private market events and helping clients with liquidity solutions. My last question to you is, what gets you out of bed in the morning and get excited about work? What makes you invested at work?

Kevin: I'm someone, Rodney, I really appreciate the question. And I've always wanted to do something on a large scale, something that could have huge impact. That's what gets me really excited. My background is I'm an engineer by training, so I've always loved problem solving, and so I have to have hard problems to solve. If I'm not challenged, I get very disengaged. So I get up out of bed by having big hard challenges and problems to try to figure out, and I've always loved sports and athletics, and even now seeing my kids and enjoying them. And I just love putting on a jersey and being a part of a team and being in the trenches. No matter how hard work is and the successes we have together and all those things, 30, 40 years from now, we're going to look back and we're not necessarily going to remember that thing that got us down on one day or the big success we had the other day, but you'll remember who you worked with. You'll remember the team you were part of and how that team made you feel and the mission you were on together.

And so, for me, being part of a team is just something that I have to have and gets me out of bed every single morning.

Rodney: Kevin, this has been so enlightening, and now when I have a difficult problem, I know who I can turn to, so I thank you for that.

Kevin: I don't know if I can solve personal problems, technical.

Rodney: Oh, okay.

Kevin: Finance problems love to, but no, no, but of course, anytime, Rodney. Anytime.

Rodney: Excellent, thank you.

Speaker 2: Invested at Work is brought to you by Morgan Stanley at Work. Produced by Campfire Labs in partnership with StudioPod Media. Our executive producers are TJ Bonaventura, Fiona Kelsey, and Mike Scholars. Our producer is Sterling Shore, our show coordinator is Nicole Genova, our project manager is Morgan Smith and our engineer is Alejandro Ramirez. Be sure to visit us at morganstanley.com/atwork for more insights on workplace financial benefits, and I'll see you next time on Invested at Work.

Not all products and services are available in all jurisdictions. This material has been prepared for educational purposes only. Morgan Stanley Smith Barney LLC, and its financial advisors and private wealth advisors do not provide any tax or legal advice. Consult your own tax or legal advisor before making any tax or legal-related investment decisions. Morgan Stanley at Work services are provided by the Morgan Stanley Smith Barney LLC, member SIPC, and its affiliates. All wholly owned subsidiaries of Morgan Stanley.


 The path of turning employee equity into liquidity isn’t a straight line—especially today. According to Morgan Stanley at Work’s 2023 Liquidity Trends Report, 37% of private company leaders are choosing to stay private longer, and 34% are unsure of the next steps. And if there isn’t an IPO on the horizon, companies need to be flexible to create more liquidity options for their employees.


This episode covers how to lead your employees through this process: from demonstrating transaction readiness through optionality, to communicating the benefits along the way and more.


This is Invested at Work. Listen in.