Until recently, shares of some of the highest-flying unicorn companies have been so hard to come by that secondary buyers have battled each other, not to mention other investors, to acquire some of the startups’ common shares.
As the fortunes of billion-dollar companies like Evernote have fizzled, however, so has their shareholders’ enthusiasm. Says the cofounder of one secondary shop who asked not to be named, “We aren’t seeing huge discounts yet in the top 10 names, but people are trying to dump them. It’s not just one person calling you about a particular company. It’s four.”
Says another secondary investor, who also asked not to be identified for this story, “We’re seeing an enormous uptick in inbound selling interest,”
The situation is changing so quickly that several people with whom we spoke say a number of new characters is now peddling shares of so-called “A List” companies whose shares would have been beyond nearly anyone’s reach six months ago. “We’re seeing a lot of sketchy people advertising these deals,” says one insider.
It didn’t used to be like this. Just a year ago, demand for unicorn stock was at an unprecedented level, as were the number of companies establishing billion-dollar valuations for themselves.
Unicorn coverage became a cottage industry unto itself, with tech outlets and even data analysis firms poring over which unicorns were the best employers, which companies were positioned to become unicorns, and which venture firms were the best at spotting unicorns early on, among other angles.
Alas, by late August, China’s market was in a nose-drive, and both late-and early-stage investors began applying the brakes. It wasn’t long before non-traditional venture investors like Fidelity and Blackrock were slashing the valuations of some of the startups in the portfolio. A parade of well-reported WSJ pieces about what isn’t quite right at high-flying Theranos seemed to cement what many had started to think: That many unicorns really weren’t worth what their ambitious investors had settled on.
It didn’t help when, last week, the human resources startup Zenefits asked its CEO to resign over sloppy and possibly damning business practices. Ten months ago, the company was valued at $4.5 billion by investors.
Which brings us back to today, when the phones of secondary buyers are beginning to ring with a little more urgency, along with discounted offers of up to 30 percent off companies’ most recent valuations. (Actually, they say calls picked up noticeably last month.)
Partly, such nervousness owes to employees, some of whom are getting laid off as companies cut back on costs in order to lengthen their runway. These former staffers have to exercise their options within 90 days or else lose them, and they’re calling secondary firms for help in figuring out what to do.
Some sellers are venture capital firms that thought they could exit some of their investments in 2016 and are now concluding that they can’t. (As some readers will know, the clock is always ticking on a venture fund. Most have 10 or 11 years, tops, to invest in startups and get some cash back to investors before losing the confidence of those backers.)
And some sellers are companies themselves that want to control employee sales before they lose control over them. “We were always getting calls from employees who’d say, “I have X hundred thousand shares; can you help me because I see my company is valued at X billions of dollars,'” says Howard Caro, a cofounder of the San Francisco brokerage firm Scenic Advisement, which helps startups arrange secondary transactions in the stock.
Now, says Caro, “Companies are asking us: ‘Can you help us structure a major tender offer to address major employee concerns before people start talking to secondary investors who we don’t want on our cap table?'”
For some of the companies, it may be a little late to start thinking about employee retention now, suggests Ben Black, cofounder of Akkadian Ventures in San Francisco, which specializes in software deals and largely buys early founders’ and other employees’ stakes.
“We look carefully at the cap structure of every company that we buy,” explains Black. “When companies choose to try manufacturing high valuations by giving onerous preference terms [to late-stage investors], they destroy the value of their employees’ common stock. We won’t buy common stock under those terms.”
More broadly, it’s growing harder by the week for shareholders to get the prices they want, or so suggest secondary investors. Says one who tracks 80 public companies that are relevant to his firm’s position, “When they go down, the price I’m willing to pay [for their private company counterparts] goes down.” Says another, “Right now, you take 10 percent off on a relationship build, or you let the [seller] call you back in two months and take 20 percent off.”
Indeed, the half dozen people we spoke with for this story suggest things are likely to get worse for primary shareholders before they get better.
That’s both good news and bad news for secondary buyers, who first saw activity spike a couple of years ago. Secondary sales totaled $47 billion in 2014, up 80 percent from the previous year, according to investment bank Evercore.
While many investors were last year seizing the chance to take advantage of booming prices, they’re now apparently trying to wring what they can out of their positions. That leaves secondary buyers left to assess whether to buy now or wait to see if prices fall even further.
In certain cases, old valuation numbers are simply being thrown out the window. “The extent to which investors are looking at deals based on their last primary [fundraise is] becoming less frequent and less relevant, frankly. If I’m a mutual fund and looking at company that raised in July 2015, my argument is going to be that [that valuation] is no longer relevant. The mutual fund is going to [come up with a new price based] on the company’s fundamentals.”
Chief economist Max Wolff of Manhattan Venture Partners, a New York-based merchant bank focused on the secondary market, echoes Caro’s sentiment. “In tech, when times are good, it’s about potential. When they aren’t, investors focus much more on fundamentals.”
Trades are still going through, says Wolff. “The best names are able to hold their valuations right now,” he adds. “But anything that isn’t perceived as a platinum name is under heavy pressure.”
Illustration by cartoonist Charles Addams.
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