Soon I’ll have spent more time on cap tables than org charts. That’s a 2025 milestone as Homebrew turns 12.5 years old, surpassing my combined working tenure across Second Life, Google and YouTube. I entered venture capital with some beliefs – many of which still hold true (such as ‘your LPs are your business partners, not your customers’). But I’ve also seen a few change quite dramatically based upon the progressing ‘game on the field’ and my own VC experiences. One example is whether it’s assumed that seed VCs maximize outcomes by religiously holding their shares until the company itself exits. I mean, we’re investors, not traders, right? You’re told ‘illiquidity is a feature, not a bug’ and ‘let your winners ride.’ But when the physics of the model shift, you often need to with it. [While I’m going to focus on investor secondary here, I support common share sales as well – for example, back in 2014 writing “Getting Some Founders Early Liquidity Can Benefit VCs” during a period where many founders were being shamed for even asking about taking some money off the table.]
Ok, so what has changed by opinions about seed stage and secondary and why will the best early stage investors know when to sell, not just when to buy? Here’s the logic underpinning why ‘buy and hold’ is being replaced by ‘buy and maybe sell.’
Was
Now
Impact on Early Stage
Timelines to Startup Exit
On average 7-10 years to IPO, M&A
10-12 years+ as founders want to keep companies private; narrative that ‘bar is higher’ to go public; more grow/crossover capital to support private companies; periods of slower M&A due to private company valuations and/or regulations
Delayed liquidity hurts LPs who manage to an IRR and even for Cash-on-Cash returns slows distributions which can be reinvested in VC and other classes
For the earliest funds (pre-seed, seed) this means instead of 10 year fund cycles for LPs, you’re seeing closer to 15, which fundamentally changes LP calculations about the asset class
CoInvestor Alignment
Mostly structural alignment across the venture sector. Everyone largely underwriting to the same outcome goals.
Growth investors were the ones who added structure to deals and best companies typically just raised a single growth round ahead of IPO.
The dominance (in scale) of the multibillion dollar AUM holders, who are often underwriting to lower outcomes and needing to put more capital to work. That is, they rather have a 5x with $300m in the company than a 10x with only $30m invested.
The alignment gap between investors *starts* at the Series A, meaning earlier preferred investors cannot assume their interests are always aligned with the rest of the cap table. Angels and seed investors are better off thinking of themselves as common with a 1x preference once tens and hundreds of millions of dollars have been raised by a company.
How Investment Rounds Are Priced
Price discovery and valuation by within a relatively small community, with an independent new investor setting market price
A global auction filled with investors who have all sorts of objectives, experience, and return goals
I’m not bemoaning higher prices – the market bears what it bears and founders will make the decisions that they believe are best for their company. But this dynamic, for certain classes of companies, also means that startup pricing is often enthusiastic, optimistic and gives the company ‘credit’ for execution against forward looking plans quarters or years into the future. This decreases the penalty of ‘selling early’ to seed investors, and adds more performance risk to the investment, especially when seed investors lack the capital to protect/recap the company.
GP Incentives
You get really rich off of carry
With megafunds, you get really rich off fees regardless, which can impact all sorts of incentives to keep private marks high (TVPI!) while you raise new funds.
No Tiny 🎻s needed, but for more modestly sized pre-seed and seed funds, the returns are where you hope to strike it rich. So DPI matters sooner.
Infrastructure Around Secondary
Opaque, shady
Several large market makers, investor and company counsel have seen this before
There are now standard and trusted processes that reduce risk for all parties around these sorts of transactions. Still need to be careful working with unscrupulous parties.
Impact Upon Startup
Any VC selling is a warning sign that something must be wrong with the startup because they have inside info
Sure, there are cases where this might be true, but increasingly, and especially when the shares are bought by other existing investors/sophisticated players, it’s less of a concern
Balancing and consolidating the cap table on behalf of the founder to make sure the later investors have enough skin in the game. Sometimes we’ve seen founders proactively asking if we want to sell because they have more investor demand than they want to service.
VC Skillset
VCs are investors, not traders. We hold until the founders and company exit.
VCs increasingly *are* traders. Every venture firm who has held crypto tokens/coins have made buy/sell decisions and some even have a trading desk equivalent.
YOLO, not HODL
Now, optimally the secondary sales will always occur with the support/blessing of the founders; to favored investors already on the cap table (or whom the founders want on the cap table); without setting a price (higher or lower than last mark) which would be inconsistent with the company’s own fundraising strategy; and a partially exited investor should still provide support to the company ongoing. But even here I recognize than in some extreme situations you, as an investor, are forced to make calls about divergence in needs between your own, co-investors, and founders. The question is can you do it professionally and situationally enough to not harm the company and not develop a reputation for being a pain in the rear. As an industry peer said to me, “I think friendly secondaries are easy, everything else feels new.”
A second point of clarity is often the secondary is being performed for reasons other than just distributions to LPs, but also helps the venture firm recycle capital to support other startups in the firm’s portfolio. That is, early partial liquidity isn’t solely about investor wealth capture but is *good* for other founders in the ecosystem. Cash flow for small firms in pro rata, bridge rounds, and so on is a real challenge, and it impacts young startups disproportionately.
For funds like his, selling stock of private startups to other investors will be “75% to 80% of the dollars that [limited partners] get back in the next five years,” Hudson told me from his office in San Francisco’s brick-lined Jackson Square.
and
Hudson said majority of the capital he’s returned to LPs over the past few quarters was through secondaries, but declined to give specific names of the companies he sold.
And my former Google colleague, turned VC Tomasz Tunguz recently wrote a data driven analysis which concluded “It’s [secondary sales] not just a temporary anomaly, but a structural evolution in how venture capital will function.”
And trust me, there are many more who prefer to keep this type of activity private but are active harvesters. Secondary is quickly becoming primary for early stage VCs.
