The San Francisco-based firm’s Private Company Liquidity Fund helps employees and shareholders of private companies monetise their equity without having to sell their stakes. It does this by extending part-debt/part-equity financing to the shareholders, collateralised against their holdings.
For early-stage employees, such financing can help them vest their share options in a more tax-efficient way. For those who are already shareholders, it gives access to liquidity while remaining invested in the company. The institutional investors gain exposure to a universe of private companies without having to buy in as a pure equity player.
Liquid Stock founding partner Robert Pitti, a former BNY Mellon and Bank of America executive, spoke to sister publication Secondaries Investor about the strategy.
How does Liquid Stock’s offering benefit employees who have un-vested stock options?
One reason [they might tap the fund] is to reduce taxes. If you hold a stock option in a big private company, you wait until there’s a liquidity event and when the lock-up expires you go and exercise your option. In California, upwards of 50 percent of the gain in that option goes on taxes.
If you can exercise your option while the company is still private, at a lower valuation, you become a shareholder and you get a tax basis in the stock. All the future gains are taxed at half that rate, so you end up maximising the value of the equity position.
For options holders that leave these companies, the standard is that once you leave, you’ve got 90 days to come up with the money to exercise the options or you lose everything.
How is it beneficial for employees whose stock has already vested?
Another case is people who already own their stock and are thinking about selling to get liquidity. In promising, high-growth private companies, this often means leaving significant upside on the table. Our solution allows them to get liquidity but hold onto more of their equity.
How does the fund make money for its investors?
There is a small upfront payment, which gets capitalised into the transaction, providing some immediate cashflow to the fund upon executing the liquidity transaction. There’s an investment return, which functions very much like an interest rate that accrues over the period of the financing. It’s received upon settlement.
Our transactions are over-collateralised typically by three times. So if we’re advancing $1 million we’re going to secure it by $3 million in private stock value. Our equity participation is expressed as a percent of the value of that collateral pool upon settlement of the financing.
How long has this been in the works?
I had my first fund executing this strategy back in 2000, which in hindsight was way ahead of its time. Post-Facebook-era, I worked with a group of partners to put together two $20 million re-proof of concept funds. They are now fully deployed. The LP makeup was primarily individuals and family groups. Liquid Stock is one of the first true institutionally backed funds focused on this new asset class.
What are your expectations for deployment?
The team here has already deployed in this strategy, probably close to $150 million. It’s a proven concept. Now we’ve got the right partners, it’s time to scale the business and really get the word out. We think we’ll be able to deploy this capital well inside two years. As more companies start to come on board with liquidity programmes based on our solution, as opposed to selling [stock], the capital requirement for that type of endeavour could potentially be larger than the fund itself.
Robert Pitti was founder of VSL Partners, a firm that provided liquidity to employees and investors of VC-backed firms. Between 2010 and 2013 he was senior director of wealth management at BNY Mellon.