Silicon Valley’s secondary market is bigger than ever

(Bloomberg) — Secondary deals involving venture capital-backed startups are on track to hit a record this year as companies such as OpenAI, SpaceX and Stripe Inc. organize tender offers to secure employee wages and investors look for ways to sell stakes to outsiders. new high. Initial public offering.

A tender offer provides a way for employees, former employees, and certain investors to sell their stock directly to other investors. That’s a change from years past, when large startups looking for a payday for their employees would go public — the traditional path to fame and fortune in the tech world.

But with initial public offerings scarce, tender offers and other types of secondary transactions have surged. NewView Capital, a firm specializing in secondary markets, expects startup deal volume in these markets to reach $21 billion in 2024, more than double the previous high in 2023.

Fintech company Carta made a total of 26 tender offers last quarter, the most since the outbreak. Fanatics Inc., Databricks Inc. and Rippling are among the companies that have recently completed or are negotiating similar deals. Meanwhile, SoftBank Group Corp. has been in talks with OpenAI to buy $1.5 billion worth of shares from employees through a tender offer, the AI ​​company’s second tender offer this year.

In the secondary market, buyers and sellers trade existing shares of private companies. This is different from a deal in which new shares are issued, which are typically shares purchased by a venture capital firm as part of a funding round, or shares that employees receive as part of their compensation. One of the attractions of such deals is that they allow investors to control when they get paid by selling their shares outside of an IPO or acquisition.

This year, the secondary market is bigger than ever: deal value is expected to top $140 billion in 2024, up from $132 billion in 2021, according to investment bank Jefferies. Previous record. And a portion of these deals are growing rapidly, NewView said, involving venture capital-backed startups. Buyers include family offices, venture capitalists looking to snap up new shares and specialist secondary companies.

In the case of tenders, some companies coordinate deals to give employees a windfall and help retain employees. Many startup employees may own stock, which makes them look wealthy on paper but does not equate to spending power.

“Net worth doesn’t tell you what you want,” said Greg Martin, who founded and runs Archer Venture Capital, a firm specializing in secondary funds, and Rainmaker Securities, a secondary stock trading platform. Because startup stocks are illiquid, “you can’t buy a house, you can’t pay for school, you can’t take care of family health issues.”

Some larger, older startups schedule stock sales regularly, often a few times a year. SpaceX and Stripe, for example, have organized several such deals. This structure can help reduce the pressure on employees to go public.

The system is in stark contrast to years past, when takeover offers were rare and those who wanted to sell shares in private companies sometimes did so quietly and rather ad hoc, perhaps using a system that matched willing buyers and sellers. platform.

“It’s kind of taboo,” said Larry Aschebrook, founder and managing partner of G Squared Investment Management LP. “Companies are thinking, ‘If anyone wants to sell my stock, I must have failed.'” That attitude has all but disappeared, Ashbrook said, largely because of the longer wait times for some large startups to launch IPOs. . The result took his secondary investing business from “struggling” to “great.”

Employees aren’t the only ones selling shares. Many venture capital firms are also selling shares on the secondary market. Over the past 24 months, venture capitalists have seen far fewer money-making deals (acquisitions, IPOs or buyouts) than in the past. Such deals barely topped $10 billion last quarter, according to PitchBook. Compare that to 2021, when returns were at least $100 billion per quarter. This makes investors more eager to seek returns outside the primary market.

Institutional investors are also involved. Earlier this year, Los Angeles County Employees’ Retirement Association said it would lower the proportion of assets allocated to venture capital and growth equity from a target range of 15% to 30% to between 5% and 25%. % Before. At the same time, the company said it would expand the group target range to include secondary shares to 35% of its growth category, compared with 30% previously.

Archer’s Martin sees opportunity in this difficult time. On the secondary market, he likes to buy shares in venture-backed companies that will be acquired or go public relatively soon—ideally within three to four years. He said he got a good price.

“The benefit of the secondary market is that it’s a little less efficient,” Martin said. “When you need liquidity,” that is, cash, “you become less price sensitive.” Startup shares are still trading at a discount on the secondary market compared to the latest official average valuation. Companies Martin holds secondary stocks in his portfolio include sleep improvement company Hatch Baby Inc., artificial intelligence computing company Lambda Inc. and writing assistant Grammarly Inc.

The market once had a reputation as the “Wild West.” Carta, for example, exited its secondary business entirely earlier this year as the company tried to get investors to sell their stock, a move that drew the ire of its founders. But the secondary market has gradually become more formalized, in part because of the growing popularity of tender offers.

While some venture capital firms remain frustrated by long and slow IPO timelines, secondary experts believe they have found a niche. “It’s exciting,” Ashbrook said.

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