editione2.1.1
Updated September 12, 2022We now turn to the question of determining the value of private company stock. Weβve seen how stock in private companies often canβt be sold, so its value is difficult to estimate.
The value of equity you cannot yet sell is a reflection of three major concerns:
How well the company is doing nowβthat is, how profitable it is, or how many customers it is attracting.
How well the company will perform in the future.
How likely it is the company will be valuable as part of another companyβthat is, whether it may be acquired.
The first concern is relatively clear, if you know the companyβs financials. The second and third come down to predictions and are never certain. In fact, itβs important to understand just how uncertain all three of these estimations are, depending on the stage of the company.
In earlier stage private companies, there may be little or no profit, but the company may seem valuable because of high expectations that it can make future profit or be acquired. If a company like this takes money from investors, the investors determine the price they pay based on these educated guesses and market conditions.
In startups there tends to be a high degree of uncertainty about the future value of equity, while in later stage private companies financials are better understood (at least to investors and others with an inside view of the company), and these predictions are often more certain.
Ultimately, the value of your equity depends on whether and when you are able to convert it into stock that you sell for cash. With public companies, the answer is relatively easy to estimateβas long as there are no restrictions on your ability to sell, you know the current market value of the stock you own or might own. What about private companies?
A liquidity event is usually what makes it possible for shareholders in a private company to sell their stock. However, individuals may sometimes be able to gain liquidity while a company is still private.
βDefinitionβ A secondary market (or secondary sale, or private sale) transaction is when private company stock is sold to another private party. This is in contrast to primary market transactions, where companies sell directly to investors. Secondary sales are not routine, but they can sometimes occur, such as when an employee sells to an accredited investor who wants to invest in the company.