Tuesday, June 28, 2011

Beware of Infernal Shares

Internal shares are private shares of stock. One of the steps that a pre-IPO company must take is to create a private pool of shares that might eventually be sold to the public.

At some point in your career you may encounter an employer that offers to sell internal shares of stock to its employees. In my experience, this is a red flag. You might want to update your resume if an employer asks you to actually purchase the shares instead of granting them.

First of all, you must recognize that there is only a very illiquid market for those shares since you can only sell them to other employees. If you leave your job the shares may have no value. Any price that might be assigned to the shares, purportedly by an independent auditor, is highly suspect without the price discovery mechanism of a public market.

Also, you may feel pressured to buy internal shares merely by the fact that your employer is offering them. If you don't purchase them will your job be in jeopardy? I was once offered such internal shares from an employer for a nominal price and fortunately my spouse talked me out of purchasing more than the minimum 100 shares.

Don't get fooled into believing that internal shares implies that your company is actually going public. My company was acquired a year or two after I dropped $500 to buy 100 internal shares. The acquiring company simply canceled the shares.

I have enountered some companies that pay the match in their 401K in internal shares. To my way of thinking that is the same as offering NO MATCH, given that the internal shares are so vulnerable. If you do not get a match why bother contributing to a 401K!? Much better to contribute to an IRA where your investment choices are far broader.


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