Mailbag: When to Sell and When to Hold

Q: Can you guys comment on what to do after an IPO as far as when to sell shares? Also, how long will you guys follow a recommendation after it goes public? Thanks.

A: Most IPOs require investors to wait 180 days before selling their shares. Buyouts don’t. I’ll comment on a buyout scenario first and an IPO scenario second.

If the startup gets bought out by another private startup, those shares are illiquid and you’ll have to hold on to them. But if the startup gets bought out by a public company, you’ll have the option to hold on to your shares (after they’ve been converted to public shares) or to sell them.

The case for holding on to them is compelling. These companies are disruptive and fast-growing (in terms of revenue) and often have unique technology that’s hard to duplicate. And the best of them meet the demands of massive customer bases in ways the competition can’t.

But there is also a case for selling. Has revenue growth failed to open up a pathway to profitability? Is growth slowing? Are new competitors emerging with better technology or business models? If the answer is yes to any of these questions, then the upside is perhaps lower than everyone hoped. And you should consider selling.

With an IPO, you’ll also have a six-month track record to consider. That covers two quarterly reports. Were Wall Street brokers happy or disappointed with the company’s quarterly results? Did the company fail to live up to its own projections? Has the price moved up or down or remained flat in those six months?

There’s lots to consider. And every company is different.

As an early-stage investor, it’s extremely likely that you’re sitting on a big profit even if share prices drop dramatically after the IPO. In general, you should consider cashing out an amount equal to your original investment. That way, however the stock does in the future, you won’t lose money on your investment. And if you can, cash out with a handsome profit. Say your shares have gone up 6X. Why not take half your gains in cash and let the other half ride? Even if your remaining half goes down to zero, you will have made 3X. But there’s a good chance that your remaining shares could go much higher, and you could double or triple the profit you’ve already made.

If your shares in the intervening six months have dropped, you might be tempted to sell the whole shebang. But don’t sell too low. These companies could very easily rebound and experience strong growth for the next several years. So I’d advise you not to cash out your entire stake. Keep in mind that the shares of public companies rise and fall, and a fall in price doesn’t mean the end of the world.

We plan to follow our recommendations for as long as it’s practical. But the final decision on whether to hold or sell is yours and depends in part on your own personal circumstances. But I hope the above gives you a framework to help you make the right decisions.

+ Andy Gordon, Co-Founder, Early Investing

Q: What are the warning signs of a failing startup? And how do I get out in time?

A: A failing startup is a difficult thing to diagnose. Almost all startups go through rough times at some point. That’s the nature of building a business.

As for exiting a failing startup, you usually can’t “get out in time.” Failure is the risk we take when we invest in startups. The equity you purchase in a startup company is not “liquid,” meaning it cannot easily be sold. Private shares are difficult to transfer.

If the startup is struggling, it’s going to be hard to find a buyer. Buyers are generally around only when a startup is doing amazingly well (and in that case, you probably shouldn’t sell). And even if you could find a buyer when the company is struggling, you wouldn’t get much for your stake.

The best thing to do when a startup in your portfolio is struggling is to help it if you can. Even if it’s just an encouraging email saying “I believe in the business you’re building. Let me know if there’s anything I can do to help.” Encouragement can go a surprisingly long way toward helping a founder get through a rough patch.

If the founders do rally and get through their hard times, the result can often be surprisingly positive. I’ve had a number of startups in my portfolio that I had essentially written off go on to produce very profitable exits (selling the company).

But if the startup does fail (and they often do), you simply need to accept it. Maybe you’ll get some money back, maybe you won’t. As startup investors, we need to be comfortable with investments failing sometimes. After all, they can’t all be winners.

Take the time to learn what you can from the experience, and use it to make better decisions in the future. That’s all we can do.

+ Adam Sharp, Co-Founder, Early Investing