Editor’s note: Sam Lawson is the Managing Partner at Abacus Capital, a specialist secondaries firm providing structured liquidity solutions to founders and investors in venture-backed technology companies. Prior to Abacus, Sam launched the secondary market business for Europe’s leading private investment platform, Crowdcube, and worked as an investor at AR Global Investments, where he helped create more than $3 billion in private company liquidity.

While it’s easy to buy and sell secondary shares of public companies over a stock exchange, in the private market it’s not quite so simple. A lack of infrastructure and convention, idiosyncratic transfer provisions at both the fund and the corporate level, and cultural practices that value control and information asymmetry make for an extremely inefficient secondary market.  

These difficulties are particularly acute in the venture market, where the vast majority of secondaries are direct (at the company cap table level) and, as such, not only require agreement between buyers and sellers, but also the company’s involvement and consent. Thus, beyond the relatively simple challenge of counterparties agreeing on a fair price, lies the obstacle of company alignment, which can be difficult when a secondary may not be in their interest. 

Take, for example, a deal agreed at a discounted price to the last round, which can be all too easy for a discerning board to block, given the optics or anchor that it may set for the next primary fundraise. Or consider a deal in which a founder or key executive sells stock. How should a board consider the impact of this on both long-term incentive alignment and the optics to current or prospective investors? These issues, coupled with complex and time-consuming transfer administration processes mean that most secondary deals end up being delayed or falling through. In fact, by some estimates, only around 20% of secondary deals actually execute.

This reality puts many founders and early investors in private companies in a challenging position. Having made significant financial sacrifices to build their business, founders may find a lack of liquidity at the wrong moment (say, to buy a larger home for an expanding family, or to care for a sick parent) creates significant personal strife, while also drawing their focus from the business. Meanwhile, investors are subject to defined time horizons for returning capital to LPs, and may find a lack of liquidity at the wrong moment detrimental to fund performance, GP fees, and their business’ overall viability.

And, of course, in the current macroeconomic environment, with intervals between fundraises and exit timelines now much longer, the issue is more pronounced. Underscoring the point, exit activity hit a record low in 2023, generating just $61.5 billion in liquidity compared to $796.8 billion in 2021. 

Understanding venture secondaries

While secondaries have been commonplace in buyout markets for some time, secondaries in venture capital have accelerated considerably over the last decade, growing to approximately $138 billion in 2023, more than five times levels from a decade earlier as shown below.

Source: Industry Ventures

Such growth has been supported by a wide range of approaches to solving the liquidity problem, some successful, some not. There are now several large brokerage platforms that assist with creating secondary liquidity in venture-backed companies, including Setter Capital and Forge Global. But these platforms still suffer problems of information asymmetry and friction in execution. Companies still need to see a reason to approve brokered secondaries and remain highly sensitive to unsponsored secondaries. News of Carta’s retrenchment from the secondary market goes to show just how difficult it is to create efficiency in such a market.

Perhaps the most productive approach so far is secondary liquidity provided at, or around, a primary fundraising round. With a third-party institutional price set as part of the primary round, the secondary, at a slight discount to account for the equity waterfall, would seem a good opportunity for buyers, sellers, and the company to align. The issue here, however, is that the liquidity needs of founders, executives, and investors often don’t match perfectly with the cadence of institutional fundraises, which are often several years apart.

Despite these inefficiencies, the overall trend for venture secondaries is good. Having seen clear growth over the last decade or so in the US, acceptance is now spreading across borders, including to Europe. In large part, this corresponds to an increase in supply, as more and more high-value growth companies have emerged here over the past two decades. That development, combined with the fact that it now takes far longer to reach an exit, has created greater demand for liquidity, which in turn has helped bring secondaries into the mainstream.  

Even with acceptance of secondaries on the rise, the issues of alignment described above act to cap activity. Look, for example, to the public cash equities market, where approximately 90% of volume traded is secondary. Compare that to approximately 7% in venture markets in 2021 ($46 billion direct secondary over $643 billion in venture funding). 

In our view, these limitations are problematic for the private markets, leading to a less dynamic, less productive, and less competitive ecosystem. What happens to a founder’s motivation, having built a strong, profitable business with further growth ahead, when she sees no liquidity after years of hard effort? And what of the momentum for the business itself? It seems clear that by taking some money off the table with a properly structured secondary, she would replenish her passion for the business, and for taking it to its next stage of growth. 

Meanwhile, offering existing employees the chance to turn some of their sweat equity into cash can lead to better retention rates, while also making the company more attractive to prospective hires. Secondaries allow businesses to refine their cap tables, making way for new investors with expertise more relevant to the company’s current needs. For investors, gaining liquidity through secondaries frees up capital to reinvest back into the ecosystem and into the next generation of companies solving new problems.

Structured secondaries ensure stakeholder alignment

A newer alternative for unlocking liquidity in the venture market is through structured secondaries, which employ transaction structures to enforce ongoing alignment between the seller and company. Such approaches have long been used in other corners of the secondary market (such as in fund secondaries or other private asset classes), but have only now begun to be applied to venture. 

Unlike a traditional secondary, where shares are bought outright, in a structured secondary, terms, conditions, and debt-like features around the acquisition of the stock enable stakeholder symmetry. As such, they can be used to address company concerns, offering flexible ways to solve for pricing optics, incentive alignment, or other sensitivities around the sale. For the seller’s part, structured secondaries may allow for maintenance of upside, optimized tax planning, and friendlier terms.

Best suited for private companies with strong recurring revenue, high gross margins, strong unit economics, and a clear competitive advantage, structured secondaries can take many different forms. Deferred payment or earnout structures, for example, where a seller receives a certain dollar amount over time, are particularly effective at ensuring ongoing commitment to the company’s growth. Alternatively, secondaries structured as, or similarly to, a loan maintain future upside potential for sellers, while ensuring ongoing alignment to the company. In many cases, lending structures can be a compelling route for those looking to manage their tax positions more effectively.

While traditional secondaries are somewhat limited — often working well for one party and not for another — that’s not the case with structured secondaries. Indeed, structured secondaries provide scope for a broader set of investors in private markets, providing for less volatile, shorter duration investments in single assets or indeed, diverse portfolios at various stages of maturity.

No matter what form they take, structured secondaries ultimately solve for alignment. In doing so, they create a viable path for a transaction that might have otherwise been met with resistance. They also provide greater flexibility in terms of timing. Whereas traditional secondaries typically happen around the time of institutional rounds — sub-optimal for founders, employees, or existing investors needing liquidity in the interim — structured secondaries are more fluid and can provide the flexibility to access liquidity when it’s actually needed. 

Unlocking the potential of structured secondaries takes specialized expertise

At a time when the need for liquidity is greater than ever, and in the context of an ever-maturing venture asset class, structured secondaries are a new and often better tool to solve the diverse needs of this important market. As markets recover in 2024 and beyond, and as venture regains its dynamism, more secondaries are inevitable. That said, it’s important to remember that structured secondaries are sophisticated products. As such, it’s essential to take care when pursuing them and to call on the help of specialists to ensure they get executed successfully.