As an angel investor, founders will likely be queuing outside your door to persuade you to put money into their companies, but what about when you want to get it out?
Most investments in private companies are illiquid, meaning you can’t simply sell the shares on the stock exchange. The three ways to get liquidity as an angel investor are secondaries, acquisition or an initial public offering (IPO).
The secondary market is a financial market where investors buy and sell securities like stock.
It is different from a primary transaction (like a funding round) where the buyer is purchasing new shares being issued by the company.
For example, if you wanted to sell shares in Apple you could do so on a stock trading app, where a buyer would agree to purchase them at the current share price.
In the secondary market, it is much more complicated.
Firstly, you need to find a willing buyer yourself, rather than the exchange doing this for you.
“If you can find a buyer and agree on a price, you can probably sell your shares,” says Patrick Ryan, founder and co-CEO at Odin.
“In some cases, there may be opportunities for secondary liquidity during a future funding round, where new investors investing in a primary issuance will also see if they can buy some of your shares via a secondary transaction."
But depending on your share subscription and shareholder agreements, there may be constraints on the sale. You may have to seek approval from the founders or the board, and they may veto the sale.
Why? Well, firstly founders and other investors likely know you but they may not know whoever buys your shares. Meanwhile, if you sell a significant stake during an economic downturn, the company’s valuation may fall — in some cases, by a substantial amount. That could have a significant knock-on effect on the business.
“Imagine I am trying to raise a Series B at a $100m valuation, implying a price per share of $200,” says Ryan.
“You may be invested at a pre-seed valuation of $1 per share, and you‘re happy to sell for $110 per share. But by doing that, you‘re implying that the entire company is worth half as much ($50m in total), which harms our negotiating position in the Series B.”
But despite these considerations, Simon Blakey, director at Avonmore Developments and chair of the investment committee at Playfair, says he has seen an uptick in the use of secondaries.
“In recent years, partial secondaries in funding rounds of my most promising portfolio companies has been a common way of taking some early money off the table — particularly if they are likely to require multiple equity raises,” Blakey tells Sifted.
If a company performs well, an angel investor might have an opportunity to sell their stake in a startup to a later-stage investor in a Series A or B round. In seed rounds, secondaries are uncommon.
That means that secondaries only really work as an exit if the company you are invested in is performing extremely well, says Reima Linnanvirta, partner at Trind.vc and president emeritus at the Finnish Business Angel Network (FiBAN).
“Secondary transactions are typically conducted at a discount to the actual investment value,” Linnanvirta tells Sifted.
“As the money in secondary is not going to the company to accelerate its growth, the money does not generate the value for the investor in the same manner, and this will be taken into account in the pricing of the transaction.”
Linnanvirta adds that there are some funds specialising in secondary transactions, but they mainly provide liquidity in the later stage of the investment cycle — Series B and later — and do not offer liquidity to most angel investments.
In an acquisition, at least 50% — but often 100% — of the company‘s shares are purchased by a third party, usually either another company or a private equity firm.
Typically, the price for the transaction is negotiated by the management team, and then approval is needed by the board and an investor majority for the transaction to go ahead.
“As a small angel investor, there are two typical scenarios: you will usually have the right to tag along when a majority of shareholders sell their shares but the whole company is not necessarily being bought, and you may also be dragged along, when a majority of shareholders agree to sell and the buyer wishes to purchase 100% of shares,” says Ryan.
Tag-along rights, also known as co-sale rights, allow minority shareholders or members to go with a majority shareholder or member who is selling their stake in the company.
If a majority owner decides to sell their shares, the minority shareholders have the option to join the sale and sell their shares on the same terms and conditions as the majority owner.
The purpose of tag-along rights is to ensure that minority shareholders do not get left behind in a sale.
Drag-along rights are designed to prevent a situation where a minority shareholder‘s refusal to sell their stake could impede a sale that is in the best interests of the majority shareholders or the company as a whole.
For example, if a majority shareholder agrees to sell the company and there is a minority shareholder with a 20% stake who has drag-along rights, the majority shareholder can require the minority shareholder to sell their 20% stake along with the majority owner‘s stake.
IPO — or Initial Public Offering — is when a company is listed on a stock exchange, meaning the public can buy stock. If it‘s a big IPO, you usually won‘t have trouble finding buyers as you are able to sell your shares on the exchange.
That said, you may not be able to cash in right away. There will typically be a ‘lock-up period’ of 180 days post-IPO, which prevents existing investors from dumping shares after the IPO and causing the overall share price to plummet.
Lock-ups are not mandated, but they are common, and they help to dispel the impression that insiders lack confidence in the company‘s future potential. People may simply be trying to cash in on gains, but it can look to new buyers like they don‘t see much opportunity for upside.
“Even after the lock-up period concludes, insiders may still encounter restrictions on selling their shares,” says Ryan. “This can arise when an insider possesses confidential, undisclosed information, and selling shares at that time would constitute insider trading.
“Such a situation might arise if the conclusion of the lock-up period coincided with the earnings reporting season, for example.”
If you own a large block of shares, an investment bank or similar organisation may need to help you find a suitable buyer even after the lock-up period, or you may need to gradually sell down your stake to avoid tanking the share price of the company.
Challenges and timeframes
So, how long could you have to wait until you can see a return? Tiina Laisi-Puheloinen, CEO at FiBAN, says five to ten years.
“Most of the positive exits among FiBAN members are acquisitions, which usually happen after several funding rounds — while the negative ones, like bankruptcies or shutting down, happen faster,” Laisi-Puheloinen tells Sifted.
“Angel investing is not a game for the impatient. But when it’s successful it can be very profitable.”
Timing, of course, is paramount. Thaleia Misailidou is an angel investor and says that around Series B, angels often get the opportunity to exit as part of a secondary transaction.
As later stage investors join the cap table, she says, they will try to ramp up a considerable stake, often offering to buy out smaller investors.
“At that point, given the low valuation at time of entry and usually the inability to follow on as the company‘s valuation increases, the angel would get a pretty good deal for their stake,” says Misailidou.
“Otherwise, particularly if you have the option to follow up to avoid dilution and depending on your liquidity needs, it can make sense to remain in the cap table and exit at a later stage along with the rest of shareholders.”
It can seem logical to some angels to wait until they see a return on an investment before making their next one — but this is behaviour Blakey discourages.
“Over the years, I have come across many angels who have paused their early-stage investment activity whilst waiting for some sort of liquidity event from their portfolio, or because they perceive themselves as ‘too old’ to be around to see any sort of return,” he says.
“[This is] depriving the market of this valuable, non-institutional source of funding. Fortunately, our options for liquidity are increasing as more players enter the market.”