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Liquidity is a hot topic for executives at private companies who are looking for ways to liquidate holdings in order to access cash in the near term. While the secondary market is a known entity for private company equity sales, it comes with a lack of transparency and perplexing intricacies that could have a big impact on the company and its shareholders.
Because of this complexity, we recently released a paper titled, Private Company Liquidity: CEO and CFO Considerations: A Guide to Secondary Transactions. It provides a deep dive into several key factors for secondary transactions, including valuation, accounting and tax considerations.
Valuation is typically one of the first questions management will address related to the secondary transactions. In addition to performing regular ongoing valuations for tax and financial reporting purposes, companies might want to perform a valuation to create a liquidity program to provide an exit for employees or raise money in the primary market from VCs.
As it gets closer to an IPO, a company’s stock will generally continue to trend up (as shown on the timeline below). Secondary sales influence the valuations around 409A and that’s why it is critical for management to estimate the fair value of options correctly, especially when the company is nearing an IPO date. You don’t want to create a difference between the 409A and ASC 718 valuation, which could occur if auditors do not agree with your fair value assessment.
Here are three key considerations when placing a weighting on secondary sales: