Monday, June 6, 2016

Corporate - Five Steps to Sell Your Private Company Stock

     I'm honored to have Dayrel S. Sewell, a friend and colleague, as a guest blogger. Dayrel is a published author in the American Bar Association Securities Newsletter and is Managing Principal of the LAW FIRM OF DAYREL SEWELL, PLLC based in New York City.

Five Steps to Sell Your Private Company Stock

When you are holding private company stock and want to sell it, what should you do? One will quickly find out that the process is different from publicly-traded securities: you can’t just click your mouse to find a stockholder to sell your shares.  The following five steps should be considered when contemplating the sale of your private stock.
First, Determine Whether You Can Sell Your Shares under Rule 144 under the Securities Act of 1933. 

At the beginning of your potential transaction, one thing to recognize is that holding private company shares doesn’t mean that you can sell it whenever and however you want.  If your shares are restricted securities or you are holding controlled securities, you must find an exemption from the Securities Exchange Commission’s (hereinafter, the “SEC”) registration requirements, such as Rule 144 under the Securities Act of 1933 (hereinafter, the “Rule 144”) to sell them in a public marketplace, such as relevant holding period, availability of current public information, trading volume formula, and so on.  See  Rule 144 provides non-exclusive exemptions under Section 4(a)(1) of the Securities Act for selling security holders that seek to resell their restricted securities. 

Restricted securities are securities acquired in unregistered, private sales from the issuing company or from an affiliate of the issuer.  See SEC, Rule 144: Selling Restricted and Control Securities, (modified on Jan. 16, 2013).  Generally, most private sales are unregistered private sales, but it is wise to ask the issuing company for details about selling your shares.  Besides, one also needs to understand that restricted securities include securities acquired directly or indirectly from the issuer, or from an affiliate of the issuer, in a transaction or chain of transactions not involving any public offering.  See Bradley Berman and Steven J Bleiberg: Restricted Securities vs. Control Securities: What are the Differences (Insight, Volume 27 Number 12, December 2013).  Moreover, if you received the securities as a gift or if securities sold on behalf of an estate or a beneficiary, the story is different.  Gift transactions are not subject to any of the limitation of Rule 144 but the donee stands in the shoes of the donor and is subject to Rule 144.  See Lloyd S. Harmetz: Frequently Asked Questions About Rule 144A ( Non-affiliate trusts and estates, and non-affiliate beneficiaries are not required to comply with minimum holding period requirement.  See SEC Rule.33-6188 (1980).

Controlled securities are those held by an affiliate of the issuing company.  An affiliate of the issuing company is a person in relationship of control with the issuing company.  See SEC, Rule 144: Selling Restricted and Control Securities, (modified in Jan.16, 2013).

Therefore, you need to clarify what type of securities you are holding before determining your next step.  Non-compliance with Rule 144 could result in rescission of the transaction, civil liability, or even criminal liability. You can find more information regarding this issue at 

Second, Contact The Issuing Company Agent As Soon As Possible. 

Transfer of private company stock subjects the seller(s) to the issuing company’s corporate agreements, such as bylaws, articles, and/or shareholder agreement.  The Stockholder is required to comply with the specified regulations among those corporate agreements, such as right-of-first-refusal (ROFR).

You should inform the company of your intent to sell/transfer your stock, and inquire whether the issuing company desires to buy-back your stock.  A buy-back is the repurchase of outstanding shares by the issuing company in order to reduce the number of shares on the market.  If the company says yes, this buy-back offer can save time and/or money in finding potential buyers.  Otherwise, ask whether the issuing company can provide you with a prospective buyers list, if available, which facilitates the finding of potential buyers.  You should also reference other Company and industry documents such as annual reports, stock sale records, and industry performance, which serve a significant role in your stock sale transaction. 

Third, Ask Potential Buyers to Execute A Non-Disclosure Agreement Before Making Disclosures. 

Providing information about the issuing company is the best way to strengthen your negotiations and the best inoculations against buyer claims of fraud and against the issuing company regarding claims of confidentiality.  Before releasing information regarding the issuing company and the potential transaction, one should request the potential buyers to execute the confidentiality agreement (hereinafter, the “NDA”) before making deal-related disclosures.

With respect to the NDA, there are many strategies and tactics to reduce your exposure to liability from the prospect of overwhelming and expensive securities litigation.  For example, an experienced securities attorney will reasonably and permissibly broaden the scope of confidential material to broaden the scope of your protection.  We strongly recommend that you should find a securities attorney to draft related paperwork for you after you decide to go ahead with your securities transaction. 

Fourth, Make a Brilliant Memorandum to Potential Buyers. 

Often when private companies desire to offer and sell its securities, they will provide a Private Placement Memorandum to the public to attract potential investors.  The Private Placement Memorandum served as a guidebook of the issuing company and gives potential investors a thoughtful understanding of material aspects of the issuing company.  Generally, while such memoranda are unnecessary for the resale of stocks conducted by private shareholders, such memoranda is a wise investment, as the documents can strengthen the shareholders sale.  In part, that’s the reason why you should ask the issuing company for related documents, such as annual report and bylaws.  The Private Placement Memorandum can include the following several parts:

1) Basic Information about Company;
2) Executive management;
3) Financial Analysis based on annual report provided by the issuing company;
4) Risk Factors; and
5) Legal Matters

Take note that the Private Placement Memorandum should include relevant disclaimer language to better guard against claims concerning the withholding of information, making false claims, or misinformation regarding the potential transaction. 

Fifth, Require Buyer to Execute Stock Purchase Agreement. 

This is the final step and you should never ignore it.  The Stock Purchase Agreement (hereinafter, the “SPA”) will regulate all related rights and obligations between you and the buyer in this transaction.  A well-drafted SPA is likely to include such sections as Consideration; Warranties and Representations; Termination; and, Governing Law, including potential matters even after the closing of the transaction.

After you finalized the Stock Purchase Agreement and received payment from the buyer, you can ask the transfer agent of the company to transfer your shares to the buyer.

- Dayrel S. Sewell

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