Activity in secondary markets related to venture-capital-backed startups is expected to hit record levels this year. Renowned companies like OpenAI, SpaceX, and Stripe are initiating tender offers to enable employee cash-outs, as investors explore alternative avenues for divesting their shares outside traditional initial public offerings (IPOs).

Tender offers allow employees, former staff, and select investors to directly sell their shares to other investors. This marks a departure from previous trends where large startups would pursue public offerings to reward employees financially—a standard success route in the tech world.

With IPOs becoming less frequent, the volume of tender offers and other secondary market activities has skyrocketed. NewView Capital, a secondary market specialist, predicts that startup transactions in these markets could reach $21 billion in 2024, which would more than double the record achieved in 2023.

The financial technology firm Carta facilitated 26 tender offers last quarter, the highest tally observed since the pandemic’s surge. Furthermore, firms like Fanatics, Databricks, and Rippling have either completed or are in talks for similar agreements.

Simultaneously, SoftBank Group Corp has been in talks with OpenAI regarding a tender offer to purchase $1.5 billion worth of shares from employees—a deal that would be the AI firm’s second such arrangement this year.

Financial Pressures

In secondary markets, existing shares of private firms are traded between buyers and sellers, which contrasts with the issuance of new shares typically acquired by venture capitalists during funding rounds or offered to employees as part of their compensation packages. The appeal of these transactions lies in providing investors with flexible options to exit their investments without relying on IPOs or acquisitions, allowing them control over when they realize returns.

This year has seen a remarkable expansion in the overall secondary market, with 2024 on track to exceed $140 billion in transaction value, as reported by investment bank Jefferies, up from the previous high of $132 billion in 2021. A quickly growing segment of these transactions involves venture-backed startups, according to NewView. Buyers include family offices, venture capitalists eager for new shares, and specialized secondary firms.

Through tender offers, some companies create opportunities for employees to access much-needed liquidity while also assisting in talent retention. Many startup employees may hold stock indicating substantial value on paper, which does not equate to actual spending capacity.

“Net worth doesn’t meet your needs,” comments Greg Martin, founder of Archer Venture Capital, which focuses on secondary funds and operates the platform Rainmaker Securities for trading secondary shares. With the illiquidity of startup shares, “You can’t purchase a house, you can’t cover school tuition, you can’t manage family healthcare expenses.”

Larger, established startups often arrange for consistent share sales, typically a few times annually. Companies like SpaceX and Stripe have undertaken multiple such transactions, mitigating the pressure from employees advocating for an IPO.

SpaceX is recognized as the world’s most valuable startup and has executed numerous tender offers. Photographer: Jordan Vonderhaar/Bloomberg

This approach contrasts sharply with earlier times when tender offers were relatively rare, and sellers often relied on private, sporadic transactions facilitated by platforms connecting potential buyers and sellers.

“It used to be seen as somewhat taboo,” reflects Larry Aschebrook, founder and managing partner of G Squared Investment Management LP. “Companies thought that if someone wished to sell their stock, it signaled failure.” This perception has largely faded, Aschebrook notes, primarily due to the extended wait for significant startup IPOs. Such a shift has transformed his secondary-focused investment firm from “a struggle” to “the best it’s ever been.”

Employees are not the only ones divesting shares. Many venture capitalists are also selling shares in secondary markets. Over the last two years, venture capitalists have seen far fewer high-reward transactions—mergers, IPOs, or buyouts—than they typically expect. Last quarter, these types of transactions barely exceeded $10 billion, according to PitchBook. In contrast, 2021 saw quarterly returns consistently exceeding $100 billion. This situation has encouraged investors to seek returns beyond traditional primary markets.

Institutional investors are also getting involved. Earlier this year, the Los Angeles County Employees Retirement Association announced a reduction in its allocation to venture capital and growth equity, adjusting its target to range between 5% to 25% of its growth category, down from an earlier target of 15% to 30%. Concurrently, it plans to increase the share of its group involving secondary shares to as much as 35% of its growth category, up from 30%.

Strategic Investments

Greg Martin is optimistic about the current landscape. In secondary markets, he targets shares in venture-backed companies likely to be acquired or go public within three to four years, securing advantageous pricing.

“A significant benefit of the secondary market is its relative inefficiency,” Martin explains. “When liquidity is essential,” referring to cash, “price sensitivity lessens.” Generally, startup shares tend to trade at discounts in the secondary market compared to their most recent formal valuations. Companies from Martin’s portfolio, whose secondary shares are included, feature firms like enhanced-sleep startup Hatch Baby Inc., AI computing firm Lambda Inc., and writing tool Grammarly Inc.

Once considered somewhat chaotic, the secondary market has matured. For example, Carta exited the secondary market earlier this year following backlash from founders regarding efforts to motivate investors to sell their shares. Nevertheless, secondaries are gradually becoming better structured, in part due to the surging interest in tender offers.

While some venture capitalists may express pessimism about the prolonged timeline leading to IPOs, those with a focus on secondary markets remain hopeful. “It’s an exhilarating time,” remarks Aschebrook.

© 2024 Bloomberg

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