Axios Pro Rata

Conventional startup-land wisdom used to be that entrepreneurs and early shareholders cashing out some of their stock was a sign of disloyalty and would lead to a lack of interest in growing the business. Those beliefs have greatly changed.

Why it matters: Secondaries are becoming a normal, and even expected, part of a startup's life.

The big picture: Despite the recent avalanche of big-name tech listings like Coinbase and Airbnb, companies are staying private longer, tying up founders and early employees' paper wealth beyond the previous norm.

• Venture capital funds are also getting larger, pushing up investors' ownership requirements in their portfolio companies. Secondary sales have acted as a side door for getting those bigger stakes.

What’s happening: A slew of new services and approaches are cropping up to support the uptick in secondary stock sales.

• Pipe CEO Harry Hurst spoke in December with Axios about his decision to let employees of the marketplace for revenue-based lending sell some portion of their equity annually for cash.
• "We're definitely seeing a shift and you're definitely going to see more Harry Hursts and Pipes. … They were also early employees once upon a time, so they know the struggles," Inderpal Singh, general manager of AngelList's Transfers product, tells Axios.

Carta, a Silicon Valley company best known for its popular cap table management software, in February debuted its exchange for private startup stock.

• So far, only its own stock has been listed for trades on the exchange, dubbed CartaX, though sources say the company is in late-stage talks with a number of others.

Between the lines: There's momentum for private startup stock exchanges sanctioned by the issuing companies themselves, but there's a delicate balance to strike.

• Control is one of the — if not the only — reasons these companies are remaining private. There’s only so much of they'll want to give up so stock can more freely trade before they go public.
• "We want to make sure that we're doing right by the founders and the companies," says Singh, when asked if AngelList has any plans to build out a marketplace for secondary stock sales. For now, it's sticking to facilitating transactions initiated by the companies themselves.

Another dynamic at play is the growing uncertainty about the recent special purpose acquisition company (SPAC) boom and slowdown.

• Some company founders are choosing to set up a secondary sale or tender offer just in case an ongoing SPAC deal falls through, says Scenic Advisement CEO Barrett Cohn, whose firm frequently helps private tech companies execute stock sales.

Yes, but: Liquidity events at Series A and B startups — especially ones with large payouts for the founders — are still rare, and can raise eyebrows among investors.

• The founders of Clubhouse, the popular one-year-old audio chat app, reportedly cashed out at least $2 million along its $10 million Series A round last May. Note that the app remains in beta, and is not yet generating revenue.

The bottom line: Startup secondaries are an undeniable part of startup-land — the question now is where and how they'll be done as the practice becomes institutionalized.

Direct listings are hailed as a more efficient pricing mechanism than traditional IPOs, so logic should dictate that the secondary stock sales in preparation for public trading are good valuation indicators. But it doesn't always work out that way.

What they're saying: "There's no algorithm that will take into account the fundamentals of a company and the emotional enthusiasm of investors," says IPO consultant Lise Buyer of Class V Group. "The key is the asymmetric distribution of information [in secondary transactions]."

• While buyers often have an inside connection to the company, sellers don’t get registration prospectuses as they do with public listings.

Buyer adds that supply-and-demand dynamics during secondary sales can't be assumed to match what happens when the company's stock gets listed on an exchange. Particularly since secondary sales involve much smaller blocks of shares with different buyside composition.

What VCs are saying: "For me, as a former entrepreneur, I would much rather have a founder take $5–10 million off the table along the way and be ready to shoot for $10 billion than take an M&A offer at $750 million because they need money to live," GGV Capital managing partner Jeff Richards tells Axios.

• Accel's Rich Wong shared a similar view, telling Axios that "a certain amount of founder secondary is healthy — in some ways it allows founders to kinda go for it."

Homebrew partner Hunter Walk adds that it can also help diversify the startup industry:

"People who don't have family money, bankrolls from previous jobs/exits — if you're founding a company, and secondary isn't available to you, you're gonna have to wait 7, 8, 9, 10 years or more to see fruits from your labor and have all this virtual wealth (in a success scenario) while real world things like student debt, family/extended family costs, etc may weigh on you.

If it was more accepted that in situations where you can get a little money out of the company once it hits different milestones, that might make it more attractive to founders with all the same skills, ambitions, etc but not the bank account to support them or their families while they get the startup off the ground."

Yes, but: There's still skepticism, especially at the early stages.

• "When you start to see Series A and B secondaries, my antennae perk up as to whether that’s the right to do," says Scenic Advisement's Barrett Cohn.
• "You want the company to have achieved some degree of genuine commercial success, not just fundraising success," cautioned Wong.

• Founders Circle Capital has raised a new $355 million fund to buy primary and secondary shares (TechCrunch)
• Dave McClure looks to buy back into 500 Startups fund (Axios)
• Getting Founders Some Early Liquidity Can Benefit VCs (Hunter Walk)

Today's tech startups and unicorns tend to be quite strict about shareholders selling their stock.

• Question: Which tech giant's stock was widely traded before it went public nearly a decade ago, resulting in much more conservative views from startup founders? (Answer at the bottom.)