Startup Equity: Staying Private in a Public World
(Part 11 in an n part series)
It is readily accepted that an IPO is Nirvana to a startup. Of course, a fantabulous acquisition will also work in a pinch. Most startups design their equity plans around one or both of these possibilities. The events increasingly trigger vesting events, earn-out periods, house purchases and early retirements. But, what if you want to build something far longer-term? What if you only want to grow, make money and accomplish some important goal? Do equity plans even work for these companies? The short answer is, they can. The better answer is they ABSOLUTELY can, as long as you and the person designing your plan know what they are doing. A surprising number of companies with no intention of trading publicly have successful equity compensation programs. We’ll stay away from the wonky technical details in this post and focus on some of the things that can help make your program successful.
Privately held companies vary in size far more than publicly held companies. How you should handle the issues varies widely depending on your company’s size, profitability and growth expectations. Many of the issues I have discussed in earlier posts (1, 2, 3, 4, 5, 6,7, 8, 9, 10) and will discuss in future posts, apply whether or not you intend to eventually have an IPO or get acquired by a publicly traded company. Feel free to go back and read some of those articles to get reacquainted.
Common Types of Private Companies and Considerations for Equity
These are technically not startups, so I will keep this brief. These are the companies that often dwarf publicly traded companies. They can be found in almost any industry. They may have tens of thousands of employees or more. Sometimes they even have to file reports with the SEC due to having so many shareholders.
These companies may use equity plans in a manner similar to public companies. The biggest difference is that there isn't a broad group of outside investors who can fund future employee transactions. This means that these companies may make a market in their stock, offer equity that settled only in cash, or more recently, offer programs that are funded through pre-approved private investors.
Profitable High-Growth Companies
These companies are in the enviable position of making money. They don't need money from investors to thrive. They are in many "old school" industries, but they can also be found in tech, biotech and other industries that typically look to VC or PE money to grow.
A surprising number of startups are profitable. These companies have very little reason to tap into other people's money, whether private or public investors. Because of this, they have far more freedom to design their plans to meet their specific needs. They don't worry about how the "next round" will dilute people. They seldom worry about getting the approval for new share allocations. They have a broad range of options.
But, they do not have outside investors to fund transactions. They must still compete for talent with companies with more traditional plans. Success drives their growth but also is throttled by current and future needs for investment. In short, they can't simply rollout a typical plan and hope it will work.
They do, however, have interesting opportunities in plan design. Some may offer a regular or occasional dividend or dividend equivalent payments to their equity plan participants. This allows people to extract some value, without needing to wait for an "event." They may settle all awards in cash or add in performance metrics that would otherwise be difficult with outside investors looking over your shoulder. They often have vesting schedules that are far shorter or longer than their less profitable or more typical competitors.
The main ingredient in their successful equity plans is playing to their unique key strength. Real money. Their profitability drives their valuations. The profitability provides funding for employee transactions. Their profitability allows employees to feel there is less risk in equity. But, in a world of unicorns, it requires a LOT of money to compete for the absolute best talent.
Family-Owned, Professional Services, etc.
These companies have often been around for decades. They know how to operate in their space. Growth is always an objective, but often not the most important goal. They have well-established company cultures and often focus on excellence before innovation.
Historically it’s has been unusual for these companies to broadly share real equity. It is more common for real equity to be reserved for a relative few at the top of the company and offer synthetic equity or no equity to the lower ranks. This paradigm is starting to shift. Professional services firms are offering more techy-style products and solutions. Family businesses are being taken over by a new generation of leaders dealing with a new type of worker. These companies are looking at things as if they are a startup with a brand new lease on life. They are exploring equity because it has become a ubiquitous element in current total reward programs.
Outside of these three types of private companies is a wild kingdom of others. There are as many potential solutions as there are business models. The point is this: Equity isn't only for tech startups and an IPO is not the perfect goal for every company. Staying private is a path that can allow companies to compete for talent in unexpected ways. Don't limit yourself to the rules that must be followed by companies who require outside funding.