Exits aren’t easy these days. As shown in the graph below, over the past decade, IPOs have comprised the majority of VC exits. The IPO window has shown signs of thawing but has yet to truly reemerge. Though M&A is another option, on a macro level it isn’t large enough to offset a tepid IPO environment. So how can investors and startup employees achieve liquidity? It turns out there is a third option: secondaries. This article will explore what VC secondaries are, their growing prevalence, and what you should consider if selling in this market.
What Are VC Secondaries?
I will first explain what they are not. Secondaries are not “primary” transactions, which refer to investments made directly into companies. An example of a primary transaction would be Andrew investing $1M in an ice cream startup named Icy. Andrew receives an ownership stake and the $1M goes to Icy’s balance sheet, where it’s subsequently used to fund operations.
On the other hand, VC secondaries refer to transactions where existing ownership stakes are purchased. Continuing with the previous example, in a secondary transaction Chloe purchases Andrew’s ownership stake in Icy for $1M. Icy itself does not receive any capital. Secondaries are not only an option for selling VCs – Chloe could also purchase an Icy employee’s equity.
The Growing Prevalence of Secondaries
The secondaries market has grown substantially over the last decade. In 2010 there were $12B worth of transactions. By 2021, this had grown to $60B, partly due to a growing number of sellers. As Keegan Hasson of Revelation Partners explains, “over the past twenty years, companies have taken longer to exit and it has grown increasingly difficult for fund managers to return cash to limited partners on the same time horizon. Secondaries open up an additional source of liquidity irregardless of the M&A or IPO environment.” Demand has also increased: as the market has become more sophisticated, the number of funds dedicated to secondaries has grown.
What To Consider When Selecting A Buyer
- Sector expertise: smoother due diligence
- Transaction experience: smoother execution
- Dedicated capital including reserves for follow-ons: quicker execution + capital to support the company’s continued growth
- Pricing: secondary transactions have historically priced at 15-20% below the corresponding company’s latest round. This discount has fluctuated with market dynamics: according to PitchBook, the median discount was 0% in May 2022, 50% in March 2023 and 31% in March 2024
- Legal obligations and company preferences: before selling to a buyer of their choosing, employees and investors should first review their legal obligations. Furthermore, they should determine if the company has designated a preferred secondaries buyer – companies put these in place to streamline the sales process and ensure that any new shareholders are aligned with their goals
In Summary
For startups’ employees and the VCs that fund them, secondaries represent a lesser-known alternative to M&A and IPOs. Understanding the nuances of option and its dynamics can be crucial for those needing to take some money off the table.
Note: technically the secondaries I’ve referred to in this article are “direct secondaries,” which are different from “LP secondaries.” If you’d like an explanation of the difference or information on related topics such as continuation funds, leave a comment or message me, and I’ll follow up with an article specific to that subject.
