You'd probably never start a business that sells just one product. Or throw all your money into just one stock. In the same way, you need to diversify ownership of the one thing you've probably invested in to the hilt: your business.
Yet for a variety of reasons, most entrepreneurs tie up thier wealth in the company they've started and in which they believe. But as the stock market assumes new heights and tech geniuses are again rich on paper through their options, it's a good reminder that you need to play it safe. All that value can disappear pretty quickly, as the collapsing of the Dotcom bubble and the Great Recession have taught us.
Privately held companies have a small range of options to consider. And consider them they must. Here are a few options for reducing your exposure to your own company:
- Consider selling part of your company. Most companies are S-Corps, which limits them to common stock. But if you reorganize as a C-Corp, which has significant tax implications, you can issue classes of stock that won't jeopardize your ownerhip. For example, you can sell non-preferred stock, or shares that lack voting rights. You can also issue restricted stock to your employees as an incentive to stay.
- Set up an ESOP. That's an acronym for an Employee Stock Ownership Plan. As the name implies, it's a plan that allows you to sell your stock ownership to employees or management over time. Employees and management have to sign off on the deal first, and you'll need to get some lawyers and financial experts on board to craft the plan. But it's a time-tested way for you to take some money out of your company.
- If you've gotten venture capital, that means your share structure has already been reorganized into different classes as part of the deal. Consider selling shares on the first round, and then selling incrementally more shares of your ownership in all subsequent rounds of investment.
This last point makes sense for some more than others, says Drew Nordlicht, partner and managing director of Hightower Advisors, San Diego, who advises high-net-worth business owners. "If you were to do this as an entrepreneur, most of the time you believe the company is wildly successful, and you're not in the product development stage, and you are willing to sell because the company is generating significant revenue."
Nordlicht recommends one more possibility: Consider the burgeoning secondary market for illiquid shares. Companies that work in this space include Equidate, SecondMarket, and the NASDAQ. In the past few years, they've sold hundreds of millions of dollars worth of stock for companies such as Dropbox, SurveyMonkey, and Facebook, prior to that company's public offering.
If your company is already public, a strict set of rules that govern insider trading apply to you. Your sale of company stock has all sorts of implications for the company and its stock price, as well as all future earnings reports the company is required to make. Still, executive stock sales are possible, and can be executed through something called a 10b5-1 plan, which lets large shareholders sell stock in a predetermined fashion.
"It's a methodical program that over the years has allowed owners to generate liquidity and diversification," Nordlicht says. Now, what are you going to do with all of that new-found money?