So you have some understanding of the private markets, equity crowdfunding, how to evaluate them, and you’ve invested in the online offering of a private company. Congratulations, you’re an investor in a nascent and exciting market! You should also have some idea of the type of returns you’ll see and when you can expect them. Owning equity in private companies is slightly different from public equities.

As you probably know, private companies can generally only sell their shares to a select group of accredited investors via a private placement Regulation D offering, but the JOBS Act has allowed private companies raising online to sell their private shares to the public via Regulation Crowdfunding (Reg CF) or Regulation A (Reg A). If you want to exit your position in any private investment, however, there aren’t many options available. In this article, we’ll discuss the ways you can divest yourself of private equity.

What is “Liquidity” in Startup Investing?

Before diving into the ways you can divest your private equity, let’s clarify a key concept: Liquidity in Early Stage Investing.

Liquidity refers to how easily you can convert your investment into cash. In the world of early-stage investing, this process is not as straightforward as in public markets. Unlike public stocks, which can be sold swiftly on exchanges, private shares lack a readily accessible market, making liquidity events less frequent and more complex.

That is why liquidity will often be cited as a major risk in Reg CF issuers’ Form C filings. To give an idea of just how long it may take for an early-stage investment to have an “exit” — that is, a positive outcome for investors — traditional early-stage angel and VC deals typically see 5-7 years on average for positive exits, with some of the largest exits (e.g. IPOs) taking 8-10 years or longer.

For that reason (among many others), startup investors are often advised to only invest with money that you don’t need to see again for 5-10 years — and possibly will never see again, assuming that early-stage startups will fail before any positive outcome.

How Can I Sell Private Shares That I Own?

With publicly traded companies, the companies can buy and sell their shares to the general public. Privately owned companies, however, can typically only be sold to a select group of willing investors, i.e. venture capitalists and others. With the enactment of the JOBS Act, privately owned companies can solicit investment from the general public via primary offerings.

But what if you invested in a primary startup offering and now want or need to sell your shares?

When you invest in and own shares in a private company, there are only a few ways you can “sell” or exit your position: via some type of liquidity event, i.e. a merger, acquisition, bankruptcy, or going public, and lastly, secondary markets or private sales, which we’ll be discussing in more detail.

Primary vs. Secondary Markets

In understanding the avenues for selling private shares, it’s crucial to differentiate between primary and secondary markets. In a primary market, shares are sold directly from the issuer — the startup itself — to investors. This is typically done during funding rounds, such as those seen on equity crowdfunding platforms or through traditional venture capital investments. These are the initial offerings of shares to the public.

Contrastingly, secondary markets offer a platform for these initially purchased shares to be sold again, but this time from one investor to another, without the involvement of the issuing company. Secondary markets thus provide liquidity to shareholders in companies that are still private and have not yet had an exit event like an IPO or acquisition. While primary markets are about investing directly in a company’s potential, secondary markets focus on trading the equity that has already been issued.

Secondary Market Sales

Secondary markets are one of the few ways early investors in startups can sell their private shares before standard exit opportunities, such as an acquisition or IPO. Secondary market transactions are essentially when shares in one private company are sold to another private party, after those shares were listed on a “marketplace”. The role of the marketplace is to put willing buyers and sellers in contact with each other and to facilitate those transactions.

In recent years, the secondary market has seen increased activity, especially as startups remain private longer and early investors and employees want to cash in their early positions. Companies like SharesPost, Forge, and EquityZen have established a market around secondary market transactions, especially for well-known pre-IPO companies. Venture firms have also been players in the secondary market with MicroVentures, 137 Ventures, and Industry Ventures being well-known for their interest and work in the secondary market. In most cases, it’s incredibly difficult to exit your position in the private markets. Furthermore, most of those secondary marketplaces require that investors are accredited investors, and will typically have very high minimum purchases, such as $10,000 or more for any willing buyers.

What about for non-accredited investors, or those looking to sell much smaller stakes in companies that may have raised on Reg CF funding portals?

Currently, the equity crowdfunding markets have very limited opportunities for secondary market sales. Netcapital had a secondary transfer platform for a few years, but discontinued it in the 2020-2021 era. StartEngine is the only platform that boasts a somewhat active secondary platform. However, numerous other funding platforms have mentioned that they are interested in or working on launching their own secondary platform.

Private Sales

Private sales, on the other hand, generally require the agreement and cooperation of the company, for both contractual and practical reasons. That means even if you own the equity and have a willing buyer, a third party, generally the startup/company, must first sign off on the sale. 

Selling your shares in a private company can be fairly difficult. If you work at a startup, own equity in that startup, and want to sell your equity, for example, your shares are typically subject to a right of first refusal (ROFR) in favor of the company, meaning the employee can’t sell their shares to a third party without offering to sell their shares to the company first. 

Limitations of Reg CF Secondary Sales

It’s important to note the specific limitations of any secondary sales under Regulation Crowdfunding (Reg CF). This regulation is designed to balance the interests of both the investors and the companies, ensuring a degree of stability in early-stage investments.

For instance, there is a mandatory 12-month holding period for Reg CF investors, which restricts the immediate sale of shares, except under very specific circumstances. For example, Reg CF may permit sale of the shares within the first 12 months back to the issuing company, to an accredited investor, to an immediate family member, or in connection with a death or divorce.

However, after 12 months, while legally permitted, Reg CF investors may still have difficulty selling their shares. The demand for secondary shares is still rather light, so investors who need to attract an investor quickly to sell their shares may have to offer them at steep discounts to what they may be worth. Furthermore, there may still be state or other local restrictions to comply with.

How Does This Relate to Equity Crowdfunding?

Much like traditional venture, investors in online offerings will have difficulty exiting their positions once invested. Given equity crowdfunding’s still nascent status and secondary market transactions being relatively difficult to execute as well as being unreported, a full-on secondary market for equity crowdfunded companies is years away from developing.

In more developed equity crowdfunded markets like the UK, a secondary market has appeared with Seedrs being on the forefront of it all. And here in the US, we have seen StartEngine Marketplace starting to gain traction.

As we look towards the future, the landscape of private market investing, particularly in terms of liquidity, is poised for significant changes. Innovations in technology and evolving market dynamics are gradually fostering more active secondary markets. This evolution could lead to increased opportunities for liquidity for early-stage investors, offering more flexibility and potentially altering the risk profile of these investments.

For those navigating this thrilling yet complex domain of private investing, staying informed and adaptable is key. The emergence of new platforms and changing regulations may soon provide more pathways for investors to realize the value of their investments before traditional exit events. As always, we at KingsCrowd are committed to keeping you at the forefront of these developments, helping you make informed decisions in this dynamic market.

Editor’s note: this article was originally written by Francis Vu and was updated and expanded by Brian Belley