Secondaries Are A Source Of Signals, Liquidity For Investors And Early Teams

In the volatile world of startups, where success and failure often hang in a precarious balance, the ability to adapt and make strategic decisions is crucial. As the landscape evolves, companies face various challenges that require innovative solutions. One such challenge that has gained prominence in 2023 is the debate surrounding startups selling secondary shares – especially after experiencing decreases in valuations. Startups, more than any business, rely on capital to fuel their growth and further development. Traditionally, primary shares have served as the primary means for raising funds, providing a cash injection that can be used to drive expansion, hire talent, and invest in research and development. However, as the market becomes more volatile, several startups have turned to the sale of secondary shares as a potential source of liquidity for early team members and investors.

Secondary Shares: A Lifeline for Early Team Members And Investors

One of the key advantages of startups selling secondary shares is the immediate access to liquidity for both the team and initial investors. In an industry where financial stability can be thin, the opportunity to sell shares on the secondary market can alleviate the financial burdens faced by employees and early investors. This liquidity can be particularly valuable in times of economic uncertainty or as a means of compensation for team members who have been with the company for a significant period. Moreover, secondary shares can help early-stage investors exit their investment with potentially attractive returns. For angel investors, seed and pre-seed stage VC funds, and other stakeholders who took calculated risks to support the startup’s growth – the ability to sell shares can be an appealing opportunity to capitalize on their original investments, especially in an environment like we have right now.

Hot Secondaries Gaining Traction: Open AI, Neuralink, Anduril, Antropik, And Cautionary Tales Including Flexport

The secondary market for unicorn companies has been experiencing significant activity following the valuation slashes that took place for most of 2023. One prominent example of this trend is OpenAI which recently attracted the attention of investment firm Thrive Capital. In a deal led by Thrive Capital, a tender offer is set to be made to buy OpenAI shares from employees, driving the company’s paper valuation to at least $80 billion – a substantial increase from a similar transaction conducted just six months prior.

The involvement of Thrive Capital in OpenAI is a testament to the strong market demand for shares of unicorn companies, particularly those operating in cutting-edge technological fields such as AI. Just half a year ago, in April, OpenAI sold employee shares to Thrive and other investors at a valuation of $27 billion. The latest transaction, however, is expected to raise the company’s value by at least three times, placing it in the ranks of the highest-valued firms backed by venture capital.

While the valuation surge experienced by OpenAI is notable, it is important to contextualize this example within the wider landscape of secondary market activity in 2023. The market has seen several VC funds actively participating in the buying of secondary shares, aiming to capitalize on the potential growth of these unicorn companies. The examples of Horizon Ventures, Accel, and Sequoia Capital highlight the various VC funds actively participating in the secondary market and their willingness to invest significant capital in promising unicorn companies. The companies gaining the most attention on secondary share platforms are AI companies. They are leading the bandwagon effect. This includes Anthropic.ai, a rival to OpenAI and Neuralink, is a cutting-edge neurotechnology company dedicated to developing high-bandwidth brain-machine interfaces that recently got FDA clearance for for its first-in-human clinical trial, Anduril, modern defense tech startup offering a suite of autonomous systems for the US Department of Defense. There are also more negative examples, which include secondaries circulating at a significant discount compared to its latest round – such as Flexport, a digital-first freight forwarder and customs broker backed by many big names.

Flexport secondary prices were a source of negative signal in this year when the secondaries were circulating on several marketplaces with around a 50% discount at approx. $4B, down from its latest round’s valuation which was $8B. While early investors stated they were liquidating their investments for personal needs – the news later came out that Flexport’s revenue decreased more than 70% in the first half of the year and the CEO, CFO
CFO
, and CHRO were fired suddenly.

Rising Popularity Of Platforms For Selling Secondaries Gaining, Some Becoming Acquisition Targets Of Funds

In this dynamic financial landscape, platforms like Carta, AngelList, Forge, Sandhill, and EquityZen have emerged, paving the way for individual investors to access the hottest startups before they hit the mainstream. Carta, a frontrunner in the game, connects investors with pre-IPO companies, enabling them to buy or sell private market shares. AngelList, on the other hand, takes a community-driven approach. Providing a platform for both startups and investors, AngelList facilitates connections and fosters relationships. Forge leverages building relationships with institutional investors and startups with their expertise in trading private market shares, they empower investors to diversify their portfolios and capitalize on emerging opportunities. Sandhill, formerly known as Stonks, is an example of tapping into the retail investor market using a gamified investment experience. By offering fractional shares of private companies, Sandhill allows investors to participate in the growth potential of startups without needing to invest large sums of money – and often via engaging weekend video streams, catering to the busy retail investor with a day job. This unique approach encourages engagement and democratizes access to the world of startups.The popularity of these platforms doesn’t stop there: the news just broke that Equation, a leading provider of software solutions for LPs (Limited Partners), is aiming to tap into the secondary market by acquiring Betterfront, an investment analytics firm specialising in secondary transactions. The acquisition is seen as a significant step towards transforming the way investors access and analyze secondary opportunities, infusing automation and data-driven insights into this relatively traditional market. The thesis argues that Equation’s acquisition of Betterfront is driven by the desire to streamline and modernize the secondary market. By integrating Betterfront’s cutting-edge technology, Equation aims to empower LPs with more efficient, transparent, and data-informed decision-making processes when it comes to secondary investments. This acquisition aligns with the broader trend of digital transformation in the private equity industry – so combining Equation’s expertise in software solutions with Betterfront’s robust data analytics platform could potentially unlock a new era of growth and accessibility for the secondary market, benefiting both investors and the broader ecosystem.

Conclusion: Secondaries Are Here To Stay, Unlocking Liquidity, Trajectory Signals And New Investor Audiences For Late Stage Companies

The lack of liquidity seems to be an ongoing theme among all stages of VC investors – the lack of M&A activities, decreased valuations accompanied by down rounds in 2023 and waves of layoffs have pushed them to seek alternative solutions. The delayed IPO market has also forced early team members and employees who counted on liquidity – to shop around, often settling on secondary platforms as the most convenient option. This will also result in an imminent inclusion of retail investors via platforms like Sandhill, as they want to participate in the value creation of the most prominent unicorn names, while funds will increasingly use signals from Carta, Forge, EquityZen and others as a sign of confidence or panic in the short, and medium run.