The conventional wisdom is that you join a hot startup pre-IPO to get the low priced stock options. Techcrunch reports that some people are joining Facebook now to get in on pre-IPO shares. I don't believe that is the motivation in most cases, but it does make me think about the pre-IPO magic. The theory is that when the company goes IPO, the stock shoots up, and you make millions. It worked in the 80's and 90's, but does it still work?
In the past there wasn't a SecondMarket where you could sell your vested options, which in effect sets a market valuation on the company. Since the IPO market dried up over the last decade there has been a movement by VCs and big investors to buy stock directly from founders and early employees, as part of a larger capital raise for the company. Again, this establishes a market value for the company pre-IPO. In the case of Facebook, the pre-IPO valuation is reported to be over $30 Billion.
IPO bump? - If private investors have already bid up the valuation, will there be an IPO jump in the stock price? Doubtful. This breaks the conventional wisdom about pre-IPO stock options. Companies are required to price their employee stock options close to the "market valuation". It is called the 409A Valuation requirement from the IRS.
The effect of the 409A requirement, and the new movement of private investors buying vested stock options from employees, is that the pre-IPO valuations, and thus the employee stock option price, are very close to the expected IPO price. So, how will there be a big bump in the stock price at IPO? My guess is there won't be a bump...and conventional wisdom will change.
With companies like Facebook, Zynga, Groupon, and others sporting multi-billion dollar private valuations, it is hard to see how there will be an IPO bump. This is however great for employees with vested stock options who now have a way to cash in some options before an IPO.
We haven't seen any of these "high private valuation" companies go IPO in the past 10 years. It will be interesting to see how public stock market investors react. What do you think?
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