There are countless privately held companies across the country who want to reward loyal employees with incentives. Employers might offer stock-based compensation or stock options in lieu of cash bonuses. This article explores privately held stock, why employees own it, and some things you should be aware of.
Privately Held Stock: What It Is, Plus Pros And Cons
A privately held stock is an ownership stake in a corporation whose shares are not available to the public.
Positives
• Companies that are not publicly traded (in theory) do not have as much of a focus on short-term stock price and can take a longer view on the future of the company.
• These companies have power to select their investors and advisors.
• These companies could go through an initial public offering or be acquired at a premium in the future, leading to potentially significant gains by the investor.
• Privately held stock may experience less price movement due to market volatility because of the lack of liquidity.
Negatives
• Because shares are not available to the public, the investor would have to seek someone to buy their shares if they need liquidity.
• Owning a single illiquid stock position puts disproportionate risk on the investor holding it.
• Unicorns, or privately held startups that reach valuations over $1 billion, are rare. As of June 2023, there are 1,200 unicorns in the world (The number of companies in the United States is around 10.75 million, according to the 2020 census).
• If companies choose their advisors or investors poorly, the company may be at significant risk.
Common Reasons Why Investors May End Up With Privately Held Stock
1. It is part of your compensation/bonuses. I’ve found this to be the most common and unavoidable way.
2. You were given stock options. This is when investors can opt to buy the stock at a fixed price for hopes they can sell it later at a higher price.
Advice For Investors
For many reasons, I do not encourage investors to hold concentrated stock for their investment goals. Individual stocks run the risk of going to $0 and broadly diversified portfolios help mitigate risk and can improve your returns.
If you’re on track with all of your individual financial goals (retirement, major purchase, education, charitable giving, etc.) and have some excess funds to play with, that is generally the only time I would say it may be acceptable to take those kinds of speculative risks and sacrifice liquidity of funds held on the side.
If owning privately held stock is unavoidable and tied to compensation, I would encourage staying in the loop about upcoming liquidity events and sale opportunities and learning if there is a system in place to facilitate the sale of these securities. Due to the risks, I would generally recommend getting out of the position, when possible, to avoid excessive exposure.
If you were to seek private equities outside of your own organization, you would need to meet high minimums in liquid investible assets to invest in this category with fund managers. Privately held stock and private equities may offer an attractive investment for those who can afford to diversify and have sufficient other assets to sacrifice some liquidity, but they are not suited for every investor.
Conclusion
Privately held stock, like any individual stock, comes with inherent risk. It can be a piece of your overall portfolio but should not be relied upon entirely for short-term or long-term investment goals. Before deciding to invest in this kind of asset class, speak with a financial advisor regarding your current risk tolerance, goals and investment needs.
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