Silicon Valley's Secondary Markets Soar to New Peaks -

Transactions in secondary markets involving startups backed by venture capital are set to hit a record high this year as companies like OpenAI, SpaceX, and Stripe are initiating tender offers to ensure employee payouts, while investors explore new avenues to divest their holdings aside from initial public offerings (IPOs).

Tender offers allow employees, former employees, and select investors to sell their shares directly to other investors. This marks a departure from previous years when major startups seeking to financially reward their employees would typically pursue a public listing — the traditional benchmark for success in the tech sector.

As IPOs become less frequent, the frequency of tender offers and other secondary market transactions has seen a sharp increase. NewView Capital, a firm focused on secondary markets, predicts that transactions involving startups in these markets will reach $21 billion in 2024, more than double the previous year’s record.

Last quarter, financial technology firm Carta facilitated 26 tender offers, the highest number since the pandemic-driven boom. Additionally, companies like Fanatics, Databricks, and Rippling have either finalized or are in discussions for similar arrangements.

At the same time, SoftBank Group Corp has been in talks with OpenAI to purchase $1.5 billion worth of shares from employees through a tender offer — this would mark the AI firm’s second such transaction this year.

Cash-Strapped

Within secondary markets, the trading of existing shares from private companies occurs between buyers and sellers. This differs from acquiring new shares, which is typically the case for venture capitalists during funding rounds or for employees included in their compensation packages. The appeal lies in the flexibility these transactions offer, enabling investors to sell their interests without depending on IPOs or acquisitions, thus allowing them to dictate the timing of their returns.

This year has seen substantial growth in the overall secondary market: 2024 is anticipated to exceed $140 billion in transaction value, as reported by investment bank Jefferies, escalating from the prior peak of $132 billion in 2021. A rapidly expanding segment of these transactions pertains to venture-backed startups, according to NewView. Buyers encompass family offices, venture capitalists eager to acquire fresh shares, and specialized secondary firms.

Some companies execute tender offers to provide their employees with essential cash while simultaneously supporting talent retention. Numerous startup employees may hold stock that signals considerable wealth on paper, yet it fails to convert into liquidity.

“Net worth doesn’t equate to immediate needs,” says Greg Martin, founder and operator of Archer Venture Capital, which specializes in secondary funds, along with Rainmaker Securities, a platform for trading secondary shares. Concerning illiquid startup shares, he asserts, “You can’t purchase a house, cannot cover school tuition, nor can you handle family healthcare expenses.”

Larger, more established startups typically arrange for share sales at regular intervals, usually multiple times a year. Companies like SpaceX and Stripe have conducted numerous such transactions. This strategy can alleviate pressure on employees advocating for an IPO.

SpaceX is acknowledged as the world’s most valuable startup and has carried out multiple tender offers. Photographer: Jordan Vonderhaar/Bloomberg

This approach starkly contrasts with earlier times when tender offers were the exception rather than the rule, with sellers often relying on discreet and infrequent transactions, sometimes aided by platforms connecting interested buyers and sellers.

“It used to carry a certain stigma,” Larry Aschebrook, founder and managing partner of G Squared Investment Management LP recalls. “Companies believed that if someone wanted to sell their stock, it indicated failure.” This investment mentality has largely dissipated, Aschebrook notes, primarily due to the prolonged wait for significant startup IPOs. This transition has transformed his secondary-focused investment business from “a struggle” to “the best it’s ever been.”

It’s not just employees who are divesting their holdings; many venture capitalists are also liquidating shares in secondary markets. Over the past two years, venture capitalists have seen notably fewer lucrative exits — such as acquisitions, IPOs, or buyouts — than anticipated. Last quarter, such transactions barely crossed the $10 billion mark, according to PitchBook. In contrast, the year 2021 saw every quarter achieving returns exceeding $100 billion. This scenario has incentivized investors to seek returns beyond traditional primary markets.

Institutional investors are getting involved, too. Earlier this year, the Los Angeles County Employees Retirement Association announced plans to reduce its allocation to venture capital and growth equity to between 5% and 25% of its growth category, down from an earlier target of 15% to 30%. Concurrently, it intends to elevate the share allocated to secondary investments to as much as 35% of its growth category, up from 30%.

Smart Investments

Greg Martin sees opportunity amid these challenging times. He tends to focus on purchasing shares in venture-backed companies that are likely to be acquired or go public in the near future — ideally within three to four years. He reports achieving favorable pricing.

“A significant advantage of the secondary market is its relative inefficiency,” Martin elaborates. “When liquidity is a priority,” indicating the need for cash, “price sensitivity diminishes.” On average, startup shares continue to trade at a discount in secondary markets compared to their latest official valuations. Notable companies in Martin’s portfolio, comprising secondary shares, include enhanced-sleep business Hatch Baby Inc., AI computing company Lambda Inc., and writing assistant Grammarly Inc.

Once viewed as a chaotic landscape, the secondary markets have modernized. For example, Carta exited the secondary market earlier this year following backlash from founders over its attempts to encourage investors to sell their shares. However, secondary markets are gradually becoming more systematic, partly due to the rising trend of tender offers.

While some venture capitalists may express concern over the extended wait for IPOs, those concentrating on secondary markets remain optimistic. “It’s an exhilarating time,” states Aschebrook.

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