If you’re a non-controlling shareholder in a private company contemplating an exit, there are several unique considerations when it comes to selling your shares. Unlike public company stock, which is easily traded on public markets, private company stock may be harder to value and sell. Private company shares may be subject to several company-specific restrictions, resulting in less liquidity and more complex transactions.
In this article, we’ll explore the key aspects of selling a non-controlling stake in a private company, providing you with the insights needed to make informed decisions and achieve successful transactions.
How Do You Value Private Stock?
Valuation is a critical aspect of selling private company stock.
Unlike public companies, where stock prices are readily available, private company stock lacks a transparent market, making valuation more complex and subjective.
When controlling shareholders want to sell their stake in a private company, there’s typically an independent business valuation and sale. This should be no different for a non-controlling shareholder selling shares in a private company. Overvaluation can deter potential buyers, while undervaluation can lead to significant financial losses for the seller.
So, it’s essential to strike the right balance utilizing a professional appraiser with experience in the valuation of private companies and private company securities; specifically, seek out professionals with appropriate business valuation certifications like the ASA, ABV, etc.
Finding Potential Buyers
Before seeking potential buyers, it’s imperative to understand any company-specific restrictions that might apply to the sale of your stock. For a non-controlling shareholder, these restrictions are often the primary concern and can significantly impact the ability to sell your shares (i.e., the marketability of your shares).
Company-Specific Restrictions
Right of First Refusal: this common clause gives the company or existing shareholders the right to purchase your shares before you can sell them to an outside buyer. It’s designed to maintain control within the company and is typically outlined in the shareholder agreements or company bylaws.
Buy-Sell Agreements: these agreements may dictate the terms under which shares can be sold or transferred. They often specify who can buy the shares, under what conditions, and at what price, which can limit your exit options.
Automatic Sales or Transfers: some agreements may include provisions for automatic sales or transfers under certain conditions, such as an employee leaving the company.
Company Rights: companies may reserve specific rights over the shares, such as the right to approve or reject any sale or transfer.
Preferred Shareholder Rights: preferred shareholders might have certain rights that need to be considered, such as first claim on dividends or assets in the event of liquidation. These rights can affect the attractiveness and valuation of your common shares.
Designated Persons Restrictions: the certificate of incorporation may restrict designated persons or classes from owning shares. This is common in closely held private companies where control is intended to remain within a family or specific group.
Citizenship Requirements: for companies in certain industries, such as national security, there may be legal requirements that stockholders are domestic citizens or residents. These restrictions are designed to comply with regulatory requirements and can limit the pool of potential buyers.
Accumulation Limits: some companies may have restrictions preventing any shareholder from accumulating too many shares and gaining too much control over the company.
Holding Periods: companies may impose holding periods requiring shareholders to hold their shares for a certain amount of time before they can be sold.
Finding Buyers
Once you understand the rules, you can start the search for potential buyers.
Internal Buyers: given the many restrictions often placed on private company stock, internal buyers – existing shareholders and employees – are typically the most practical or even the only available buyers.
External Investors: external investors like venture capitalists, private equity firms, or strategic buyers may be an option if company restrictions allow. However, many of these investors may not be interested in non-controlling deals due to the lack of influence over company decisions.
Brokerage Services: specialized brokers can connect you with a wider range of potential buyers who may not be accessible through internal or direct contacts. However, company restrictions may limit the pool of buyers, reducing the likelihood that a brokerage service will take on the transaction. Brokers also charge for their services, which can reduce your net proceeds.
Considerations and Challenges When Selling Private Stock
Before proceeding with any sale, you must ensure compliance with all relevant agreements and regulations. You need to review company-specific agreements, such as operating agreements, shareholder agreements, and bylaws. They often contain important information about transfer restrictions.
It’s worth noting that certain transactions can trigger state and federal securities laws as well. Given the complexities of these regulations, it’s crucial to consult with expert advisors before offering any private stock for sale. They can help ensure that your offer and sale comply with all contractual, legal, and regulatory requirements.
Tax Implications and Planning Strategies
Selling private company stock can trigger various tax consequences, depending on how and when you sell your shares. If you’re concerned about the tax implications of selling private stock, there may be ways to minimize your tax liabilities. A tax advisor can provide more comprehensive information and help you develop a tax-efficient strategy tailored to your situation.
Get Expert Guidance
This article provides a brief overview of the process and considerations involved in selling private company stock for a shareholder and a non-controlling shareholder. If you’re considering selling private stock, it’s important to consult with financial planners, tax advisors, and business valuation professionals to ensure the sale aligns with your financial goals.
For more detailed information and personalized guidance, please contact Tony Oman, MBA, ASA-BV, Director of Business Valuation & Transaction Advisory Services, or one of our other expert advisors.