bwagy, the blog of Ben Young

This is the third in my recent posts about investing (100 Companies, Investment lens, what I’ve been up to). More about the discoveries I’ve made the past 18 months or so. This post is on secondaries, that is buying shares in later stage startups. This is an area that has been getting more and more democratized. Examples might be a SpaceX or a Stripe.

The present market state, is such, that for institutional investors who want exposure to future IPO companies there are a lot of options. For individual investors the options drop off compared to that but are still available.

Who can do this?

Typically the minimum is $50k, however some platforms come down to $10k depending on the deal. So these are sizable investments. Which hold a lot of risk, an IPO or acquisition isn’t certain. However you can buy in to quality companies that you want to own.

You also need to be a qualified individual under US law.

How are they structured?

Typically the firm creates a SPV to hold the secondary shares and you are buying units in that entity. You can hold the units directly or you can hold through your own entity.

Can you buy a ‘fund’ of secondaries?

Yes, most providers either offer these in batches over time or continual funds.

Where do they get the shares from? Why are those people selling?

Typically these are early employees selling their shares, it can also be funds from early investors selling a portion of their stock. You might think they’re crazy to sell stock in such a hot company. But these holdings might represent most of their gains or all of their net worth. A smart individual would sell some, to at least pay off the mortgage, diversify.

The other thing is, life happens. The employees may have left or are leaving. Tax bills arise.

But you are right to be skeptical, maybe they are selling as bad things are on the horizon. Be attentive if you’re seeing a lot of sales or a depressed price. That is where your own due diligence needs to come in, a long term outlook and to listen to the market.

The final way is some firms offer financing for startup employees to exercise their option or to buy their options if they are leaving. If they finance the exercising of the options, they typically take some upside. So in each case they are on-selling their asset.

Right now, you also have to question why aren’t they going public now? Typically they have access to capital and a good plan to keep growing in the private markets. Or they have more work to do to get the business ready.

Information issues, rights & lock ups

Because these are secondaries, you are going to get imperfect information. Prior financing may have additional warrants or the total amount of issued shares may be inaccurate. Typically they are close but don’t go in to this expecting to lift the kimono and see everything.

The next thing is rights, you likely will not get information rights to receive updates from the company. And also will not get a vote etc. You just get the exposure to the upside.

As these are employee shares, you will likely be held to the same employee lock ups. Meaning you may have public stock for 3 or 6 months. Further for tax compliance, you will receive K1s each year.

How do the firms offering these make money?

The firm offering it will charge a placement fee and take some carry. Carry will be calculated on the IPO price, or an average of the last 30 days of trading if a lock up period is in place. There may be a management fee as well to maintain the entity and compliance.

Imperfect pricing

To set expectations, because this is a secondary and limited supply available, you are typically going to get imperfect pricing. You may be buying at a discount, or a premium to the last round.

Tips

• Be fast, hot companies can get allocated very rapidly. As fast as 8 minutes I’ve found.
• Friday, I tend to see the offerings coming on a Friday. I’m not sure why, my guess is that they’ve spent all week finalizing the details and now need to get it out.
• Complete your KYC details early. KYC is know your customer and requires validation of who you are, or your entity, and your role in acting on its behalf.
• Insidery, hot companies are going to go fast so often *may* be provided to their top or most frequent investors first. I haven’t seen this as a strict policy but observed it happening. So do put the highest allocation you could make when you indicate interest and let your account manager know your interest or flexibility.

Who are some of the firms that offer these?

• MicroVentures, from my observation they appear to have the best deal flow for ‘retail’ like investors. They provide companies, small funds with a collection of companies.
• Forge, they merged with SharesPost to offer a broader array. They also have a good volume of deals.
• EquityZen, a generalization but they tend to have more media/NY offerings. Lower minimums.
• EquityBee, is similar to EquityZen, they also tend to have a mix of different types of companies. Lower minimums too.

Those are the main ones. The Forge founders are also working on a new company, which may yield new options in the future.

Here are some offerings that *may* in the future offer more options for retail but offer options for those with larger commitments:

CartaX is more for institutional right now, but may have more retail like options in the future.

SecondMarket, acquired by Nasdaq also is on the same path. Providing offerings in private companies.

SecFi, they fund employee options and take a portion of the upside, and will sell some of that exposure.

GSquared, they also offer options for family funds.

What about Crypto?

There have been coins been sold against soon to be public companies, like Coinbase & RobinHood. The coin represents, converting the initial capital at the first day of trading. So this gives you synthetic exposure without underlying stock ownership. This is a space I would expect more to happen over time.

This entry was posted on Saturday, August 28th, 2021 at 2:57 am.