Ask HN: Optimal strategy to sell startup shares?

[HowDoIEquity]

The recent a16z post about "How Startup Options (and Ownership) Works" made me wonder this. Suppose you own N shares of a startup you work for, and that is doing really well, i.e. its valuation is increasing, but it may also fail at any time. What's the optimal strategy to maximize profit and minimize regret?

An example of what I mean. Suppose N represents 1% of the startup, which is currently valued at $100M. You sell your N shares and get $1M. Yay! Except a year later it's valued at $10B, so your N shares would be worth $100M. Conversely, if you don't sell at $100M and a year later the startup folds, and you end up with $0.

A better strategy may be selling N/2 shares at $100M valuation (getting you $0.5M), and then either your remaining N/2 share are worth either $50M or $0, so you end up with either $50.5M or $0.5M, which is neither $100M nor $0.

This makes me think there may be more complex models based on risk tolerance (reward vs regret), probabilities of success, etc. But I can't be the first person to think about this, so before throwing math at the problem... is there a standard, reasonable way to do this?

[toast0]

In the hypothetical situation where the stock has a clear value, is liquid, and you have no organizational penalty for selling; I would want to limit at least the vested stock to some percentage of my net worth -- maybe 5%-25%.

However, it's very likely that you would not have liquidity, or that trying to sell your vested shares will upset the organization and may make it harder to vest further shares.

[tylercubell]

Reverse Dollar Cost Averaging. Because you can't predict the future, sell a fixed amount of shares on a regular basis.

[AnimalMuppet]

Don't make the decision based on taxes.

I had some options. They were in the money, and the price looked very sweet. But I had already sold enough that year to push me to the border of the next incremental tax bracket. It was mid-December, and I decided to wait.

But two days later, the company announced a deal to purchase another company, and the stock market didn't like it, so the price tanked. I missed the sweet price to avoid paying the taxes on those sweet gains. (That is, I avoided taking $X of income in order to avoid paying Y% of $X in taxes, assuming that the $X would still be there later. Don't assume that.)

[mmastrac]

Sell enough to bump your life up to the next step - keep the rest. With your given example, sell $500k and pay off your house (or buy a house somewhere reasonable for cash). Keep $500k and roll the dice for whatever it turns out to be.

[bachback]

Great question. An optimal strategy doesn't exist, because it is so circumstantial. The employee and founder (the seller) need a good idea about the price and probability of success. Making a buy/sell decision either way certainly effects outcomes, independent of the ultimate success. It really depends how the seller values the stock, and how that differs from the buyers valuation. Knowing a lot about (startup) stock valuation will certainly help. Probably its more political than anything, because the price of a 100M$ company can fluctuate wildly, and so being in similar situations should help as well. I don't know much about Silicon Valley, but there you have a lot of investor driven companies (people raising money to push the value, to raise more money, etc. without a real business seems much more common). The 10B$ outcome is exceedingly rare, so the employee should think really hard about the value (see Moskovitz talk about it here at 36:00 https://www.youtube.com/watch?v=CBYhVcO4WgI)

Usually 1M$ will be much more valuable when going from 0 then the next 1M$. In the example it seems irrational not to sell for 1M$, if the employee doesn't have already a lot of money. But usually people are not given the choice and need a liquidity event (IPO or acquisition). If one assumes that shares could be liquid from day 1 the dynamic changes. Most likely options will have vesting.

The real issue here however, in most cases, is that there is no liquid market until very later stages. So the company might be worth 100M$ in its entirety to sell, but employees can't sell options. Also simple options might actually not be the best instrument, but it is too costly to customly define an instrument for every employee. Say an employee could be an option which maximizes wealth for 0-1M$ (1%). If the total value hits 100M$ the other owners could buy out those options cheaply, and both sides win. Having only one strike price makes the potential value curve extremely steep, making startup shares more like lottery tickets.

To consider an extreme case - Google. Page almost sold Google for 1.6M$ in 1997 Luckily he didn't. In many cases it really depends on the belief of the founders/employees/investors. For employees it seems that their problem is more that they can't sell earlier than the liquidity event, which is due to the fact that IPO's are so expensive.

With Crypto-finance there will be the potential to create a market for stock at almost no cost, which will change the game, because it allows to float stock from the earliest stages when the most wealth is created. It will be much more common for employees to exit early and for the wealth to be more widely distributed. Getting to 10-100M$ is magnitudes of order more common than the 1B$+ exits.