Before an IPO the shares of the startups cannot be freely traded. Besides legal restrictions imposed by federal securities and state Blue Sky laws, there may be restrictions imposed by the company (e.g. vesting, limitations on transfers, company’s rights, etc). Besides founders, shares of the startup can be owned by employees and independent contractors who received them as a part of their compensation. While at the beginning of the business, all participants are usually guided by the same goals, the circumstances of some may change down the road. Let’s imagine a shareowner with a vesting schedule is willing to continue working for a company until his shares vest, but needs money at the present. Or a founder who has an agreement with his co-founders to sell the company, but cannot wait for an exit event for some reason, needs money now. Usually the shares of a startup company are totally illiquid. However, there are some limited mechanisms that allow getting liquidity before the exit even. One of them is a forward contract.
A forward contract is a private, over-the-counter contract for a sale of a specified asset at a specified price on a specified future date. The buyer of the assets in such transaction bets that the price of the assets will be much higher once they become liquid than what he’s paying now. It certainly is not easy. Such transactions are pretty speculative and include a great deal of risk. For these reason the buyers are usually experienced investors and brokers.
Forward contracts are similar to, but should not be confused with futures contracts. Futures contracts are standardized and traded on registered exchanges, while forward contracts are custom-made private agreements between two parties.
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