Navigating the Secondary Market: Opportunities and Challenges
Dec 13, 2024
Gavin Freeman
Throughout 2024, secondary transactions become increasingly significant in the venture capital world. As the secondary market grows, understanding how to capitalize on its opportunities is essential because these transactions often involve complex structures, regulatory considerations, and strategic decision-making. Navigating these complexities effectively allows investors and fund managers to unlock liquidity, gain access to exclusive investment opportunities, and maximize returns.
For those new to secondaries or looking to deepen their strategy, our Guide to Secondary Sales offers foundational insights. This piece dives deeper into structuring deals and unlocking the vast potential of secondary transactions.
Structuring Secondary Transactions
Understanding the Right of First Refusal
The Right of First Refusal (ROFR) is a provision granted in venture deals that gives a company the right to either approve or block future sale of equity shares into the company, and it’s typically activated when an investor wants to entertain a secondary sale. If an investor wants to sell some of their shares, they have to offer those shares to existing investors with ROFR before offering them to external third parties.
Think of ROFR as a safety net for private companies. It helps them preserve ownership stakes and prevents unwanted third-party investors who might not align with the company's goals from gaining access. For anyone looking to execute secondary transactions, understanding the company’s ROFR requirements is important because it affects whether they can do the deal at all.
How SPVs Support Secondaries
SPVs, particularly layered SPVs, play a key role when it comes to secondary transactions. While secondary transactions activate the Right of First Refusal (ROFR), transferring interest in an SPV does not. This means you're not directly trading shares on the company’s cap table; instead, you're trading interest in an SPV that owns those shares.
Investors can purchase shares of high-demand late-stage companies through layered SPVs because it sidesteps potential blocks from the company via ROFR. If you own shares through an SPV, you can freely sell your interest—either to another person or another SPV—without triggering ROFR.
More emerging managers and syndicate leads are adopting this approach, and an increasing number of our customers are using Sydecar's platform for these transactions. For more on how Sydecar supports layered SPVs, visit our page here.
Entering at a Better Price Point
Sometimes, secondaries can provide a better entry point into competitive rounds. For instance, imagine an investor who was unable to secure a spot in a hot funding round for a late-stage company due to oversubscription. After the round closes, another shareholder—perhaps an early employee or an angel investor—decides to sell their shares via a secondary transaction. The company’s valuation might have been marked up during the funding round, but the seller offered the shares at a modest discount because they needed liquidity.
By purchasing these secondary shares, the investor not only gains access to the company but also enters at a potentially more favorable price than what was available in the primary round, sidestepping the competitive pressure of the initial allocation.
Insights on Fees and Scale
Secondary transactions often come with unique fee considerations. One-time fees, management costs, and other expenses can vary significantly depending on the transaction’s complexity. Understanding these structures—whether fixed fees or scaled percentages—is essential for accurate budgeting and planning. On Sydecar’s platform, the average management fee for secondary deals is 2.19%, and the average carry per deal is 10.24%.
Looking Ahead: The Future of Secondaries
Evolving Market Dynamics
The secondary market, while still small relative to the broader venture capital market, is expanding rapidly. Secondary transactions currently provide about $120 billion in liquidity annually, a fraction compared to the over $20 trillion in assets under management globally. However, the potential for growth is significant. As illustrated in our State of the Secondaries Market report, Sydecar’s data shows that the average amount raised in secondary deals has nearly doubled, from $969K to $1.8M per deal year-over-year, showcasing robust secondary market growth.
Growing Interest in Tender Offers
According to Michele Schueli, GP at Armyn Capital, tender offers are emerging as “the new IPOs.” A tender offer in this context refers to a situation where investors purchase shares directly from current shareholders of a private company, rather than investing in the company through new shares. This can include buying shares from founders, early employees, or early investors. With many companies delaying public listings, tender offers provide an efficient way to offer liquidity to employees and early investors while staying private. This trend is likely to continue as private markets evolve. Read more about Michele’s theory in our customer highlight piece here.
Navigating the secondary market requires a strategic approach: structuring deals effectively, overcoming challenges, and leveraging emerging opportunities. Whether you’re managing multiple share classes, exploring tender offers, or unlocking liquidity for your investors, secondaries offer unparalleled potential in today’s venture capital landscape. Explore how Sydecar’s platform can help you take advantage of opportunities in this growing market:
