Getting rich from secondary sales
Part 3 of 3 in our month long series on Employee Equity
Over the years, I’ve wired hundreds of millions of dollars to founders and early employees in secondary transactions.
(Author’s note: I also once accidently wired 8 figures to the wrong person, but we won’t talk about that today because it triggers my PTSD (Post Treasurer Stress Disorder) and I’m writing this from the fifth floor)
Releasing those wires is a surreal feeling. You try to remain all professional and “business as usual”, but you know you’re changing that person’s life (and maybe their descendants’ lives) forever.
Today we’ll discuss what secondary transactions (more formerly called “tender offers”) are so you’re prepared to take advantage of one when the time is right.
More specifically we’ll cover:
What are secondary transactions?
When do secondary transactions occur?
What’s the strategy behind secondary transactions?
What’s being bought / sold?
What are the typical rules and guidelines for participation?
What are some of the potential downsides?
What are some well publicized examples?
What are secondary transactions?
Privately held venture-backed companies often grant their employees stock options as a form of compensation. This incentivizes employees to work hard and contribute to the company's growth, as they have a vested interest in its success. It also helps attract talent at a lower salary - the company gives you less cash today in exchange for unlimited upside tomorrow.
However, these stock options are typically not liquid until the company goes public, which can take several years. As a result, many pre-IPO companies allow their employees to participate in tender offers, commonly called secondary transactions, which allow them to sell a portion of their vested shares to outside investors.
A tender offer is a liquidity event in which a company, investor, or group of investors propose to buy a fixed number of shares from existing shareholders at a set price. Tender offers can be made for both private companies and public companies, with recent examples Stripe and Twitter.
It’s important to note that the company does not get any money from a secondary transaction. The balance sheet does not change. While primary dollars are used to fund future operations, M&A, and to hire more talent, there are no new shares created in a secondary transaction, as they merely change hands.
From the company’s perspective, there’s no operational or financial benefit to doing one. And if I’m being really honest, it’s a total pain in the ass to administer. The company merely acts as an approver, book maker, and conduit by which employees and early shareholders match up with new or existing institutional shareholders. I’ve wasted dedicated hundreds of hours of my career coordinating between employees, early angels, future shareholders and the army of lawyers on both sides of the transaction.
When do tender offers occur?
Tender offers typically occur in conjunction with a later stage fundraise (Series C and beyond). This is the sweet spot where founders have been at it for long enough to take a little off the table.
Anytime before then is usually a pretty big red flag to investors - it would be suspect if a Series A founder wanted to line their pockets before the company has achieved product market fit.
That’s why all tender offers require board approval.
