Receiving a tender offer for a portion of the equity you’ve accumulated in your company can be a tempting proposition that may or may not make sense for you. In this blog post, I’ll be breaking down considerations, tradeoffs, and planning opportunities when evaluating if moving forward with a tender offer makes sense.
First, what is a tender offer?
A tender offer is a solicitation by a company or a third-party investor to purchase your equity in your company (whether that’s in the form of shares or options). Employees and other eligible shareholders have the opportunity to sell (i.e., tender) a portion of their vested equity in return for either cash proceeds or more favorable terms on newly issued equity.
Why might you (the employee) consider accepting a tender offer?
The most common reason is for diversification purposes. For example, suppose you were an early employee in the company and have accumulated a substantial amount of equity in the company. In that case, you may want to diversify a portion of your equity to lock in the gains you’ve experienced.
You may also be considering accepting a tender offer for personal financial reasons, such as a home purchase or paying down debt. While it’s common for us all to be overconfident in increases in the share price of the company we work for, there is still the chance things don’t work out. In a worst-case scenario, you could see the value of your shares completed wiped away.
However, the closer you are to an IPO (or merger/acquisition), the greater the potential for a liquidity event in which you could see the value of your shares increase dramatically. For this reason, I’m often skeptical of utilizing tender offers. Usually, the tender offer is at a substantial discount to the current fair market value (409A valuation), which puts you at a disadvantage from the jump.
Also, consider who is on the other side of the trade. If a third-party investor is looking to acquire additional shares, then they must have conviction in the future growth of your company.
So how should you go about evaluating the tradeoffs of divesting your shares given your personal circumstances?
In an ideal world, if you don’t need the current equity in your shares and have a large appetite for risk, it usually makes sense to continue to hold until post IPO when shares are publicly traded. The largest share price increase usually occurs when a company goes from private to public. Once shares of a company are publicly traded, the market does a pretty good job of pricing in future growth expectations. Therefore, you should have confidence that the share price reflects a fair valuation. At which point, you’d want to strongly consider diversifying your equity to lock in your path to financial independence.
When should you consider accepting a tender offer?
If your equity in your company represents greater than 50% of your investable assets (retirement accounts, taxable accounts, etc.), then it could make sense to take a portion off of the table. While subjective, any time you own more than 10% of your investable assets in one company, that represents a concentration risk that you should consider when making financial planning decisions.
Other factors within your personal financial situation, such as your liquidity (or lack thereof), high-interest rate debt, or short-term goals (house purchase, education, etc.), could impact your need to sell a portion of your equity. It’s important to review the opportunity cost of these various decisions. For example, if you have high-interest rate debt (greater than 10% interest), that offers a “guaranteed” rate of return when paid down with proceeds of your tender offer.
In general, if you don’t have an immediate need or a clear purpose for the use of the tender offer proceeds, it usually makes sense to decline the offer. While there are always downside risks with keeping equity in any company, if you’ve made it to the point where you’re receiving tender offers, chances are your company’s growth potential is well intact. If you have the capacity to continue holding onto your equity, it usually makes sense to do so, given the windfall potential.
If you are anticipating a liquidity event, make sure to review your tax planning opportunities with ISOs in particular. By exercising earlier, you can lock in lower valuations which can help to avoid potential AMT liabilities and get the clock ticking on long-term capital gain treatment.
As always, this blog post should not be relied upon for personalized investment or tax advice. It’s strongly recommended that you consult a tax and/or financial professional.