Private companies and/or their shareholders can decide to sell stock to third parties in a variety of circumstances. With even very profitable private companies taking much longer to exit or go public, a private stock buyback is a way of consolidating control and/or providing liquidity to primary shareholders. In many other cases, founders, employees, and other primary stockholders decide to sell their shares to third parties simply as a personal financial decision – realizing the value of the shares you own can sometimes not wait until exit/IPO.
Regardless of the context, private stock transactions are subject to securities law regulations as well as other common restrictions that should be kept in mind. Here, we provide a quick overview of the most important things to keep in mind.
Rights of First Refusal
In most cases, although not all, private stock is subject to a right of first refusal. This means that, before stock in a private company can be sold to third parties, it must be offered to existing shareholders. Selling company shares in breach of such a right of first refusal will leave the seller liable for damages toward the buyer, and the buyer obliged to sell the stock back to the shareholders who had the right of first refusal.
Board Approval Requirements
Rights of first refusal are useful to startups as a way of protecting and consolidate ownership over the private company only to the extent that they have money to buy the shares in question. This is not always the case. As a result, it has become increasingly common for a private company’s bylaws to stipulate that stocks may not be transferred in secondary sales without board approval. Again, if that is the case, selling or buying without board approval will lead to liability for damages.
It may be the case that private stock issued to an employee is subject to repurchase by the company in the event that the employee is no longer affiliated with the company. This means that, although the seller is able to lawfully sell his or her shares, those shares are always open for repurchase by the company if certain specified events occur. This could impair the future value and liquidity of the shares for the buyer.
In a secondary sale of private stock between two private investors, the buyer does not have to be an accredited investor. Where the secondary sale is open to the general public, however, the offering must be registered if it does not fall under specified exemptions. In practice, this usually means that buyers must be accredited investors in these cases.
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