Founder liquidity refers to a founder accessing the value of their shares without harming the business or the other shareholder. Some of the founder liquidity options include the following.
1. Getting A Loan From The Company
Here, the company gives the founder a loan at very reasonable rates. There are some things to note with this loan which include the following.
• The loan will be reflected on the company’s balance sheet and needs to be cleaned.
• The founder could realize the nominal carrying costs of the loan and capitalize the interest into a loan balance.
• It must be a full recourse loan.
• Depending on when the executive wants to sell the shares through a liquidity event there is always a market risk pinned on the shares. In some cases, the founder can negotiate with the board, investors and underwriters to sell shares in an amount to cover the loan obligation and any associated taxes.
• There’s also the option of loan forgiveness. Here, the company could forgive the balance of the loan or offer the founder a bonus but there is a clawback if the founder leaves before a certain period.
2. Company Share Repurchase/Potential Future Grant
Here, the company will repurchase their shares at the current market value of the common stock or at a predetermined price. There are a few things to note here.
• It can be done as a one-off transaction or an equity round.
• The transaction would be treated as sale of stock for tax purposes. The founder needs to pay the capital gains tax on the realized gain.
• Also, any new equity grant will allow further retention if the vesting conditions are in place.
3. Direct Or Secondary Sale ( For Secondary or Institutional Investors)
Here, the founder will initiate a direct sale of their common share to an existing or a new investor. Some of the things to note here include:
• The investor can purchase the common shares at a discount and not the preferred round price. However, they are at a premium to the 409 (a) price.
• A sale to the existing investor could bring some 409(a) implications that should be considered before the transaction is completed.
• There might be some restrictions and limitations related to the company’s right of first refusal. There might also be other limitations on transfers applicable. The company should consent the sale or transfer of company stock.
4. Taking A Loan From A Third Party
It might be very tough to lock in. Here, the founder will retain the equity ownership interest and voting rights. They will also benefit from any potential appreciation in stock. Unlike the other loan, this one doesn’t reflect on the company’s balance sheet. The method is frequently used to purchase any stock options in a holding pattern for ultimate long-term capital gains.
Note that, it’s a non-recourse loan using the shares as collateral. It’s usually used for companies with imminent exit plans but should have sufficient collateral to support the loan.
Before choosing any of these liquidity options for founders, it’s prudent to go through the repercurssions for each option and choose the best one.