The Ultimate Guide on Selling Private Stock
D espite all the attention that the stock market gets in the world of investing, most companies do not trade publicly. Going through an initial public offering brings several challenges, and many companies prefer to privately issue stock to employees or investors. If you own private stock, selling these shares requires a different approach than simply trading on the stock market. Learn more about how and when to sell private stocks to reap the highest returns.
- Just like trading a public stock, investors need to make sure they sell their private stocks at the right time.
- Pricing private stock is more complicated than public stock, and there are different approaches to calculating an accurate selling price.
- Pre-IPO stocks are easier to liquidate than non-pre-IPO stocks. The reason is that there is a secondary market in trading stocks for companies that are about to go public.
- Most people purchase private stock by exercising a call option on the shares.
- When investors sell their private shares, they’ll pay taxes based on the length that they held them.
Determine the Value of Liquidity
Keep in mind that if you want to sell private shares, you need to determine the value of liquidating your shares before proceeding with the transaction.
Determining the value of liquidity means finding the cash value of the private stock. With this value, it’s key to find out whether it’s worth it to sell the stocks sooner rather than later. A good reason to liquidate in the short term is typically to fund a significant life event, like paying a down payment on a home.
If investors have no major life events on the short-term horizon, it might be worth holding their shares and waiting for the stock’s value to rise. People who hold private stock are often close to the company, which can give them a better indication of whether the value of the stock they hold is likely to rise. Holding stock without any immediate need to liquidate can be a smart decision that leads to large future windfalls.
Don’t Try to Quickly Flip Stock
Many investors avoid immediately selling stocks once they buy them for a few reasons, one of them being that most company executives discourage the practice.
The executives at private companies tend to look unfavorably at people who try to resell their stock soon after they get it. Given that many of the recipients of private stock are also current company employees, it shows good faith when they hold their stocks for at least a year before trying to sell them.
Aside from the unfavorable view that executives may have of a quick stock resale, regulators also prefer that private shareholders demonstrate an intent to hold their shares. There is no regulatory minimum holding time, but it’s best to stick to the guideline of waiting 12 months before considering selling private stock to satisfy both company executives and regulators. A potential bonus of holding is that the shares could grow in value during the holding period.
Understand Your Shareholder Agreement
Every company that has shareholders needs a shareholder agreement. The document outlines the rights people have as shareholders of a company. Investors can also find limits on how much company information they can reveal to potential buyers and the financial and tax guidelines when selling the stock.
It’s vital to read through and understand the shareholder agreement because this document regulates exactly how shares can be transferred between private shareholders. By understanding the shareholder agreement, investors can ensure they follow the rules without the risk of losing their shares.
Choose a Pricing Model
When selling publicly traded stock, the pricing of that stock depends on the current state of the market. The economic forces of supply and demand set the price at which an investor can sell their shares. This relatively uncomplicated pricing approach is part of what makes trading public stocks so approachable for many investors.
With private stock, choosing how to fairly and accurately price the shares becomes more complicated. One approach investors can opt for is to find a comparable publicly traded company and apply that company’s price-to-earnings ratio to the private company.
Another more complicated pricing method is discounted cash flow analysis, which calculates the present value of future cash flows using a discount rate. The difficulty with discounted cash flow analysis is that it requires several assumptions, such as choosing a suitable discount rate and estimating future cash flows.
In scenarios where there is a dispute over the value of shares, there are several businesses that specialize in providing professional valuations for privately held shares to ensure they are sold at a reasonable price. It’s also worth getting a professional opinion if you feel uncertain about the value of your shares.
Understand Pre-IPO and Non-Pre IPO Stock
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It’s important for anyone considering selling private stock to understand the difference between pre-IPO and non-pre-IPO stock. An initial public offering (IPO) is when private shares are offered to public investors. Many private companies plan to go public, and in the industry, they are referred to as being pre-IPO. The shares of pre-IPO companies are easier to cash out. Several online marketplaces exist that specialize in trading pre-IPO shares by connecting sellers and investors of those shares.
Non-pre-IPO stock is more difficult to sell because the private company that issued the shares does not intend to go public any time in the near future. In cases where the shareholder agreement stipulates that company shares can actually be sold to outside investors, it can be difficult to convince outside investors to buy these shares due to a lack of information. The shareholder agreement tends to limit the information about a company that its shareholders can disclose, and people don’t like to invest in companies they have little information about.
Another difficulty is that the company’s decision-makers might not give the go-ahead for selling shares to outside investors. The most straightforward approach with non-pre-IPO stock is to determine how other investors have sold their shares and attempt to sell in the same way.
Selling Private Stock Back to the Company
A common method of selling private stock is for investors to sell their shares back to the company that issued them. Some private companies have share buyback programs in which the company agrees to purchase back a set number of shares. These buyback programs are sometimes termed tender offers.
In many cases, share buyback gives investors a simple way to get a fair price for the shares they want to liquidate. Buyback programs can also be used for employees who purchased stock after exercising stock options but who are leaving the company.
Account for Tax Implications
When people purchase private company stock, they often do so by exercising call options. A call option gives investors the right, with no obligation, to purchase shares for a specified price before a specific date. There are specific tax implications for investors selling private stock held as a result of exercising a prior call option. The main tax implication is the payment of capital gains taxes.
If an investor exercises their option to buy shares and sells within a year, they pay short-term capital gains tax. The rate of this tax is the same as the investor’s usual income tax bracket. If the investor holds their shares for at least a year after exercising the right to buy and two years after the option was granted by the company, they pay long-term capital gains tax on any gains. The long-term capital gains tax is lower than the short-term rate at all tax brackets.
T here are many things to consider when selling private stock. From tax implications to pricing to shareholder agreements, it’s generally much more complicated to sell privately held shares than those purchased on the stock market. By thinking about these factors, you can approach the decision to sell your private shares from a more informed perspective.