What it means
The phrase is most often used for founders and employees of young companies. They own shares valued at a high price in the latest funding round, so their holding looks very valuable, but they cannot spend it.
Until the shares can be sold, the wealth stays on paper. The gap between paper value and cash value can be wide.
Private shares often cannot be sold at all, and when they can, buyers usually demand a discount for the lack of a ready market. Taxes add another layer.
In some countries, exercising stock options can trigger a tax bill even before the shares are sold, leaving a paper millionaire with a large tax charge and no cash to meet it. The idea also applies to investors with concentrated positions.
Someone with most of their wealth in a single company's shares can see their net worth fall sharply if the price drops, and selling a large block can itself push the price down. Anyone assessing a person's finances, whether a lender, adviser or partner, should ask how much of the wealth could be turned into cash within a reasonable time.
They should also ask at what discount. This is why advisers talk about liquidity as well as value.
A balanced plan sets aside enough cash for living costs and taxes, then sells part of a concentrated holding in stages when allowed. Doing so turns some paper wealth into something that can actually be spent or invested elsewhere.
In practice
Real-world examples.
Example
A software engineer holds options in a start-up valued at $400,000,000. On paper, her holding is worth $1,200,000, but the company is private and she cannot sell. She still has to cover rent and a mortgage from her salary. Her financial adviser suggests selling a small part when the company allows it.
Example
A bank reviews a mortgage application from a business owner whose net worth is mostly shares in his own company. The lender discounts the shares heavily when assessing his ability to repay. It asks for evidence of cash income instead. The lender notes that steady cash income counts for more than paper wealth.
Example
An early employee of a listed company holds shares that have risen in value to $1,500,000. A lock-up agreement stops her selling for six months after the listing. During that time, a market fall cuts the value by a third. She decides to sell a small share when the lock-up ends and keep the rest invested.
Formula
Calculation
Paper wealth = number of shares x share price
A founder owns 400,000 shares in her private company, valued at $5 per share in the latest funding round. Her paper wealth is 400,000 x 5 = $2,000,000. If a buyer would only pay a 30% discount to that price, each share fetches 5 x 0.70 = $3.50. The realistic value is 400,000 x 3.50 = $1,400,000, and her bank balance is only $30,000.Case study
Seen in the real world.
Kestrel Labs is an illustrative, fictional technology start-up. Its co-founder, Imran, held shares valued at $3,000,000 after a funding round, and he considered himself well off.
When he tried to buy a house, the lender looked only at his salary and savings of $45,000, and declined the loan. The shares could not be sold until the company listed or was acquired.
Two years later a sale of the company at a lower valuation turned his paper holding into $1,100,000 in cash. The illustrative lesson was that the headline valuation overstated what he could spend, and that planning around paper wealth is risky. He later wrote down what he would do in each scenario, including a sale, a delay and a fall in value, so that his personal plans no longer depended on one number.
Watch out
Common mistakes.
- Counting paper wealth as spendable cash, when it cannot be used until the underlying asset is sold.
- Assuming the latest valuation is what a buyer would pay, when a sale often happens at a discount or at a lower price.
- Forgetting tax on exercising options or selling shares, which can take a large part of the gain.
Questions
People also ask.
Is a paper millionaire really a millionaire?
On paper yes, but until the assets can be sold their real value may be lower and they cannot be spent. The most useful check is to ask how much could be sold within six months, and at what likely discount to the quoted value.
How can a paper millionaire reduce risk?
By selling part of the holding when allowed, diversifying into other assets and keeping enough cash for living costs and taxes. A lock-up period is a time during which insiders may not sell after a listing, so it can keep wealth on paper for months.
Does the term apply to investors in listed shares?
Yes, in a looser sense, because gains on shares are only paper gains until they are sold.
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