Let Your Team Sell Shares Before Going Public
Secondary rounds for founders are very common. Usually, founders sell a small portion of their shares when their company reaches its B or C fundraising round. By that stage, founders have been probably building their company for 5+ years. The logic is that if you own shares worth tens or hundreds of millions, you should at this point be able to enjoy some fruits of your labor. Starting a company is all-consuming and a massive grind. Allowing founders to sell some of their shares helps reduce burnout.
But founders don’t build companies alone. Once startups find product-market fit they scale and bring on an amazing team to go from initial traction to world dominance. Those team members also go through a massive grind and have shares that are worth a lot of money. So why not let them enjoy the fruit of their labour as well?
While some companies are starting to offer a secondary sale for their team members, not enough do. I hope this blog post encourages more founders and boards to share their success with their entire employee base. Mainly because it is the right thing to do. And if that isn’t enough for you, here are a few more reasons:
- Attract more talent. The market for tech talent is extremely competitive and many public companies offer restricted stock options. Your shares as a private company aren’t liquid. So your employees can simply get more going to a public company.
- Increase retention. Allowing employees to sell shares increases retention. If you embrace employee secondary sales as an ongoing strategy and incorporate them into every funding round, people have an additional incentive to stay for the long-term.
- Increase engagement. Allowing employees to sell shares increases engagement as it shows that their options are worth real money. Otherwise, options can seem too abstract to motivate people, especially if a big exit like an IPO is many years away.
How to do a secondary round for employees
Once you’re on board with doing a secondary round for employees, you have to address the logistics. There are two key parts. The first is how to orchestrate it with investors. The second is how to implement it once you get the board and investors to agree.
How to get a term sheet with an employee secondary offer
Every fundraising round should start with how much money you need to raise to execute on your plan. After we aligned on that number with our board and finance lead, we shared with the board our knowledge that some startups offer an employee secondary at C stage rounds. From our research it was around 10% of ownership, meaning that employees could sell 10% of their vested shares. We did the math and it came to a few million dollars. The board was very supportive.
The next stage was fundraising. To do a secondary you need to create enough demand for your company to not only cover your desired investment but also the additional secondary amount. We followed this playbook and created a market for our company.
Surprisingly, when we went to raise, almost every investor asked if we were interested in offering a secondary. So that was pretty easy. We said yes and shared the 10% number. Everyone agreed. The key here again was to ensure there was enough demand for the round. If you can’t fill it, you can’t offer a secondary.
The last step was to insist it was incorporated into the term sheet once we got it.
How to communicate to your employees and offer the sale
The challenge of a secondary round doesn’t stop with your raise, however. While you would think employees would jump at the opportunity to sell shares, how you communicate to them makes a big difference.
We announced our C round to 200+ BenchSciers at our end-of-year event. We then told them that we were going to share our success with all of them. The team was very excited and appreciative. The advice we got from our lawyers was that statistically most eligible employees actually choose not to sell their shares. One reason is that they think it’s a loyalty test. So we made sure to communicate that it isn’t a test and we truly want them to enjoy the fruits of their labour.
After that company-wide communication, we started with the operational part. We sent a formal communication to every BenchScier with a detailed overview of the secondary process. This included the timeline with key deadlines to confirm interest as well as the expected closing date, how much equity they were entitled to sell, our financial results, a lot of important legal terms and conditions, and most importantly, how they could calculate the number of options they each had available to sell along with the total proceeds they would receive.
Since we wanted to ensure every BenchScier could make a fully informed decision and understood the full impact of selling their equity, we went a step further in building out resources for the team. We provided information to explain in more detail what a secondary offering is, how it works, and a list of answers to the most common questions. Also, our Finance team hosted multiple information sessions in addition to 1:1 meetings to answer any questions the team might have. We really cared about providing the team as much information as possible to reduce potential uncertainty and encourage participation. To make the process easy, we circulated a Google Form to our team to collect their interest in participating.
After confirming participation interest, we worked with our lawyers to circulate purchase agreements with participating BenchSciers to confirm the sale of their options as well as outline the proceeds they would receive. As part of the closing process, we also had our lawyers circulate the share purchase agreement with existing investors as they were purchasing an offsetting amount of equity to complete the secondary transaction. This part of the process involved a lot of communication between us and our lawyers as you need every participant to sign their agreement before you can officially complete the entire transaction, so there are a lot of follow-up emails in getting everyone on board.
After getting the agreements signed, our Finance team processed the payments through a special payroll run, which allowed us to deduct the necessary taxes and give every team member that participated their well-deserved money.
Yes, this was a lot of work. And not every company will choose to do it. But in the end, most people who were eligible participated in the secondary round and expressed gratitude for the opportunity. So it was well worth the time and effort, is a precedent we intend to stick with and is something we hope inspires other companies to follow suit.