How would you deal with a serious offer for pre-IPO shares?

[jimbob56]

I was an early employee for a company I left about four years ago. I was able to negotiate a reasonable options package which I exercised long ago for only a few thousand dollars. Up until a couple years ago, i had assumed the 'lottery ticket' would never pay out.

Well, as it turns out, it looks like the company will IPO later this year or early next (as in the CEO has stated openly that this is the plan).

Anyway, brokers, middlemen and private investors have started contacting me via LinkedIn, as they can see that I used to work for this company. I've mostly ignored them up until now, but I was sort of curious what a serious offer might look like, so I responded to one recently. They forwarded an offer (via email, nothing Legal or binding) that would value my shares at around 80% higher than the previous round of funding by the VCs. In total, it would pay out in the low seven figures, which sounds like a lot, but due to my age (early 40s), family obligations (wife and 2 young kids) and where I work and live (SF Bay Area), this is, unfortunately, not the type of windfall that would enable us to retire and live off interest or anything even close to that. Mostly it would allow us to afford a middle class home in a decent school district (we've always rented), maybe shave 5 years off our current retirement trajectory, take care of college expenses, buy a new car (current is 9 years old) and maybe take a vacation to some place exotic. Not too shabby, right?

So, assuming this is actually a serious offer (no reason to believe it is or isn't at this point) the challenge in all of this is that there is very little data on what the company is worth today or what it'll be worth on the open market, at least until they file an S-1 and we can get some hard data to look at. I have looked at comparables that have IPOed in the past few years, and can certainly get it down to a certain range of likely outcomes, but lots can change in a year and I really don't have much else to go on other than what the latest round of VCs paid.

I am all read up on the logistics of dealing with a windfall once it's there, but I'm still at the hemming and hawing stage. Should I really consider selling a portion or all of my shares (assuming I get representation from a lawyer clueful in this kind of pre-IPO share transaction) or wait for the open market to set a price at IPO? I'm having difficulty looking at the situation objectively I think because I've already held the shares so long, greed may be clouding my judgement and I haven't gotten any other offers to date from which to compare. I suppose if a dozen investors had sent me offers by now and I could see a consensus, I'd feel more comfortable making a decision, but no such luck at this juncture.

So I suppose the question is, what's the Boglehead-y thing to do? Is a bird in hand really worth two in the bush? What if the bird (private investor) represents a 100% chance at a middle-class lifestyle and the bush (IPO) represents a 65% chance at an upper-middle class lifestyle, 30% chance at a middle-class lifestyle and say 5% chance at nothing?

[Elbowman]

So I suppose the question is, what's the Boglehead-y thing to do? Is a bird in hand really worth two in the bush? What if the bird (private investor) represents a 100% chance at a middle-class lifestyle and the bush (IPO) represents a 65% chance at an upper-middle class lifestyle, 30% chance at a middle-class lifestyle and say 5% chance at nothing?

How did you come up with those numbers? Would you still be on the fence if you had a 33% chance at upper-middle class, 33% chance at middle class, and 33% chance at nothing?

[jhd]

A few thoughts.

1. Have you checked out SecondMarket? Before you do anything, see if you're really getting a good offer. Maybe 80% over the previous funding round is under-market. If you're talking about making a 7-figure transaction, it pays to do quite a bit of diligence and look for a good offer.

2. A good lawyer should be an enormous help, as you pointed out. Again, for this kind of money, I would look for someone good from a reputable firm that covers the startup world, like Fenwick, Orrick, Gunderson, or Goodwin.

3. Would you be restricted from selling immediately after the IPO? If so, that increases your risk a bit, since prices often go down in the months after an IPO.

4. Without inside information, it might be worth soliciting some offers, and selling 50% now and 50% later (or thirds, or quarters). Think of that as reverse dollar-cost-averaging: not knowing whether the price will go up 5x or down 5x, the best way to reduce risk is to sell in stages.

5. If it were me, I'd definitely hold some to the IPO for two reasons. First, the "tracking error" of missing out on a good IPO would be psychologically difficult. Second, IPOs usually happen when a company is doing well. Companies spend the 12+ months prior to the IPO doing everything they possibly can to make the offering a financial success, so it would be rare for a company's value to decrease in the 12 months leading up the IPO. (The more likely risk is that they don't go public in 2014 at all due to something unforeseen today.)

[DualIncomeNoDebt]

If you are a shareholder, you may be, and likely are, entitled to the financials, and probably can make a books and records request as well. Depends on state law and state of incorporation. Shareholder = owner. You're an owner of the company, just like anyone else, and rights attach to your shares. Don't wait for the S1.

I'd get professional advice and undertake a serious look at your ownership interest. You're swimming with the sharks now, if they can get your shares for a steal, believe me they will flatten you and your family to get their hands on them.

[dgm]

+1 on checking second market. I would not be surprised if they are trying to pull a fast one on you hoping that you don't know that second market exists.

[jimbob56]

I've actually checked SecondMarket before, but there doesn't seem to be any way to gauge share prices for my company (though it is listed there). It seems as if the company itself needs to sign up and allow SecondMarket to broker trades, which it hasn't done. Even then, it looks like the company still needs to ok each transaction and there is no 'last share trade price' publicly available so far as I can tell...

[jimbob56]

If you are a shareholder, you may be, and likely are, entitled to the financials, and probably can make a books and records request as well. Depends on state law and state of incorporation.

Interesting, I never considered that. They're a Delaware Corp.

I left the company 4 years ago and sort of assumed I am not an insider any longer, and would be able to sell shares immediately upon IPO. If I make this request, does that have any impact on that status? I suppose not, since the information would become public prior to IPO?

[momar]

I don't understand. You write you have been contacted multiple times and only followed up on one of them to get an offer. Then you write you would be more comfortable if you had other offers to compare it to. So get the other offers.

[jimbob56]

I don't understand. You write you have been contacted multiple times and only followed up on one of them to get an offer. Then you write you would be more comfortable if you had other offers to compare it to. So get the other offers.

Well, I haven't had a lot of contacts, just four so far and three of them came before the recent VC round. One was a lowball and the others I simply told to go away because I assumed at the time that they would also be lowballs. I'll see if I can dig them up. Now that the latest VC round has been closed, it seems to have put a floor on the price, so I suspect offers will be more serious going forward. I want to be in a position of power as I consider those offers, but I'm not confident that I can read the value of the company as well as the type of seasoned private equity investor I'm likely to run across.

[Valuethinker]

Construct 2 scenarios.

Scenario I: you sell half, IPO at 4x the share price you have now (for pre IPO rounds, the usual number is probably around 2x, there may be some averages out there, however things have been getting overcooked of late-- Facebook had pre IPO sales at its IPO value, I believe)

You get out 12 months after IPO (usual lock in, I think) at 4x.

Scenario 2: you sell nothing now, IPO at 4x.

This is a question of utility of money. What probability do you have to place on 2, to make you abandon 1? Bearing in mind I have pushed it on 2 (ie I have made it seriously painful to choose 1). Of course the right multiple for 2 might be 10x, and you are right to try to find out as much as you can. But 4-5x would be good multiple of money for a 'C' round VC, say (ie 10-20x for the seed/ A Round investors).

By playing around with scenarios like this you can discover your own discount rate.

Having been (briefly) a dot com paper millionaire (and lost it all, basically) I am a big fan of 'taking money off the table'. But not all your money. So 1 would be my preferred option. If you sell 20% too cheaply that's really not a big worry (50% even, in truth, ie the shares are worth $15, you sell them for $10).

However 1 may not allow you to achieve your housing goal.

So another way of looking at this might be 'what is the minimum amount of shares I can sell now, and still achieve my housing goal eg 20% down on a place where I can imagine living long term, with a mortgage locked in at an interest rate I can afford?.

Or a third way of looking at it might be: 'what is the least amount of money I can take off the table, and still feel OK if I lose the rest?'

If you surf around 'venture capital valuation' you might find some good tips what VCs are looking for. In this 'pre IPO' days (dare I call it a bubble?) driven by low interest rates and enthusiasm for social networking companies, I suspect we are closer to 2x for companies that are clearly going to make it to IPO. Feels a bit like a bubble, but remember I said that in 1996 and there were 4 years more to go for!

[Valuethinker]

Taking my idea further

Use a spreadsheet to construct a series of scenarios 1. no money off the table 2. 50% off the table 3. 100% off the table

then 'flex' the IPO price against the price you are being offered now.

See on that table where your gut says you are OK with it-- ie at what level did the utility of money now (aka buying that house) exceed the utility of more money in the future?

My own view is you are going to take somewhere between 1/3rd and 2/3rds off the table now. Maybe the range is 20% to 60%. But something like that. You'd probably be wrong not to sell *something* (even 10%) so if the whole thing cratered, you'd still have something to show for it. Conversely I don't think you should sell 100% because regret is such a powerful thing in life. You'll spend the rest of your life going 'I could have been a contender' (well, I would).

[bdpb]

So I suppose the question is, what's the Boglehead-y thing to do? Is a bird in hand really worth two in the bush? What if the bird (private investor) represents a 100% chance at a middle-class lifestyle and the bush (IPO) represents a 65% chance at an upper-middle class lifestyle, 30% chance at a middle-class lifestyle and say 5% chance at nothing?

A million bucks in hand is already upper middle class (even in SF). I'm assuming you already have a well paying job and have accumulated other assets.

Are there differences in tax obligations based on the way you receive the payout?

Stick to your Boglehead values. Individual stocks carry uncompensated risk.

[hlfo718]

Any idea if the company has already signed with an investment banker? If so maybe you can contact a private banker, except Goldman where their min is way high, within the IB and tell him/her you may potentially open up an account there if they can help you with valuing and selling the shares. Once you get your cash you transfer out to Fidelity or Vanguard.

[Valuethinker]

Any idea if the company has already signed with an investment banker? If so maybe you can contact a private banker, except Goldman where their min is way high, within the IB and tell him/her you may potentially open up an account there if they can help you with valuing and selling the shares. Once you get your cash you transfer out to Fidelity or Vanguard.

Although I would be the last person to tell you that Wall Street behaves with integrity, I nonetheless counsel against being untruthful in financial transactions and relationships.

This is for reasons of legality, ethics and spirituality. It is bad karma and it pollutes who and what you are. Just because the world is full of sharks does not mean you have to behave as one.

If you don't intend to have a long term relationship, don't pretend that you will. There is a difference between saying nothing and lying, of course.

[TomatoTomahto]

Any idea if the company has already signed with an investment banker? If so maybe you can contact a private banker, except Goldman where their min is way high, within the IB and tell him/her you may potentially open up an account there if they can help you with valuing and selling the shares. Once you get your cash you transfer out to Fidelity or Vanguard.

Although I would be the last person to tell you that Wall Street behaves with integrity, I nonetheless counsel against being untruthful in financial transactions and relationships.

This is for reasons of legality, ethics and spirituality. It is bad karma and it pollutes who and what you are. Just because the world is full of sharks does not mean you have to behave as one.

If you don't intend to have a long term relationship, don't pretend that you will. There is a difference between saying nothing and lying, of course.

I'm reminded this morning how often I agree with you.