The Liquidity Option for Equity Based Plans

“Winner must be present to win.” – common note on many raffle tickets

How many times have you participated in a raffle and noticed this “condition” boldly printed on your ticket?  I have been at more rubber chicken events than I care to acknowledge and I always cringe when I notice this warning.  My immediate reaction is always the same – is this event so bad that they have to bribe me to stay until the end?  We all know the winner is never announced before the very end of the evening – and once that lucky person stands up, we all head for the exits.

I think the parallel in business is ownership liquidity and in particular, the quandary many owners face to provide some cash to minority shareholders as they exit the business.  I have advised many long established enterprises and it does not matter what life cycle stage they are in, there is always this “Sword of Damocles” hanging over their head.  What happens if one of the owners leaves or passes on?  The remaining shareholders feel burdened by the commitment to buy out the departing party and it is this very concern that causes many shareholders to be silent about liquidity in their buy/sell agreements or not establish an equity sharing plan in the first place.  Perhaps the uncertainty as to growth and/or success also plays a role here.

Up until a few years ago, I had only seen this issue and mindset at more established businesses; usually in legacy type industries. Enter the current tech early stage growth phase (one of a few in my lifetime) and equity sharing is back with a vengeance.  However, this round, I have seen a different mindset sprinkled in with the plethora of discussions on stock options, restricted stock, etc.  There have been a good number of equity based schemes that really only have value upon a defined liquidity event.  No vesting or granting of ownership – simply stated – the holder of the ownership instrument must be present at the time of the liquidity event to benefit.  In essence the “winner must be present to win.”

Now, I do not mean to imply that equity in an early stage growth company is like a raffle ticket (actually, I think the raffle odds may be better) or that such an instrument should be seen as a bribe to keep you someplace that you do not want to be.  But, many would espouse that it is the team that creates the true value and unless the team stays until the end (liquidity) there may be no value.

So, if you are a young entrepreneur, you may want to think about this approach as one of the alternatives you consider.  As usual, please consult your professional advisor before reaching a conclusion.  While there might be some tax cost involved, think about the time, effort and expense you may have to endure to address that equity owner who has vested and now wants to leave and get fair value for what they feel they contributed.


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