Startups are taking longer than ever to exit. The time taken to reach a merger, acquisition or initial public offering for venture capital-backed technology companies has risen dramatically from a median period of seven and half years in 2006 to almost 11 years in 2018.
That means that founders and employees can wait over a decade for access to liquidity. Add Covid-19 into the mix and that wait is only going to get longer.
The question is, can, or even should, businesses expect workers to wait that long when their companies perform well?
Staff could be cash-poor, but millionaires on paper — and while that might be a strong motivator at the start of the journey, 10 years down the line, there might be a different perspective. Major life events and changing priorities mean that people could well want to access liquidity ahead of the business’ schedule. But is that possible?
Good for the employee
It is through secondary share selling — finding a buyer for your shares in the company. However, it’s a process that’s not often particularly clear, thanks in part due to a lack of awareness of the options available to both businesses and individuals.
Despite this, it does happen — New York-based video advertising platform Teads underwent two secondary share sales in late 2016, ahead of its acquisition in early 2017. More recently, through secondary transactions, we invested in Depop, the London-based fashion marketplace app, and in AirHelp, a US-based air passenger compensation company. Purchasing secondaries from these exceptionally successful companies directly benefited employees as it enabled their access to liquidity.
“…preventing people from selling shares could impact morale and speed up departures.”
Startups (and investors) have historically been wary of letting employees (and founders) cash out. There is a school of thought that suggests retaining equity is a demonstration of loyalty — but on the flip side, preventing people from selling shares could impact morale and speed up departures. Employees could well have little or no intention of leaving, simply wanting to have cash for a personal matter (such as buying a house, getting married, or starting a family).
Some companies are proactively looking for solutions for their employees. We’ve recently seen several companies across Europe reviewing the opportunity to engage in secondary transactions; TransferWise publicly discussed their secondary investment recently, for example. Generally, however, these are the exceptions for companies not yet at the unicorn stage.
Good for the startup
In some ways, it’s surprising that this remains a relative rarity. While startups and their investors might have initial misgivings, to reject the possibility of a secondary share sale outright would be short-sighted. As well as the benefit to employee morale, there’s also the opportunity to bring in new cash and experience (if a new party acquires the equity) without the hurdles of a more traditional fundraising round.
“…to reject the possibility of a secondary share sale outright would be short-sighted.”
Another added benefit is the infusion of both cash and experience. That is to say, when an investor acquires shares from employees they are helping to address the immediate liquidity needs of the seller, while also stepping in to become a value-added investor; providing continued access to growth capital and introductions to their broader network which in turn helps support the acceleration of the business.
So, what’s the catch?
That said, a secondary sale isn’t exactly a doddle. Assuming the cash, and the willingness, are in place, then the deal can go ahead. However, to ensure it is successful, a number of different points need to be addressed. Specifically, these include valuation of shares, accounting considerations, tax implications for both employees and business, regulatory and legal requirements and, finally, potential HR challenges (for instance, needing to maintain equality amongst colleagues with similar equity holdings).
Another consideration is where both businesses and individuals can turn for advice. The secondary share selling process suffers from a lack of transparency, and impartial advice can often be in short supply.
This is where investors have a role to play. A step removed from the day-to-day of the business and its operations, they can bring their knowledge and understanding of funding and the implications mentioned above of share selling. When coupled with the experience of working across different businesses, investors are well placed to provide a solution that meets the needs of both company and individual.
The investor role in the future of secondary share selling
There are clear positives to allowing founders and employees a degree of flexibility. The old fears of founders or employees cashing in and heading off shouldn’t hold the opportunity back — what matters is how secondary share selling can help startups achieve that next level of growth by injecting fresh energy while boosting employee morale. That’s why investors should be actively helping to find ways to support startups sell secondaries ahead of exits.
Olav Ostin is managing partner of VC firm TempoCap.