Latest / The Startup Exit Podcast with Fexingo: IPOs, Acquisitions, and Founder Liquidity Events / How Founders Use Secondary Sales for Pre-IPO Liquidity
Transcript
- Lucas: If you're a founder sitting on a chunk of equity in a company that's still a year or two from IPO, and you need cash — for taxes, for a home, for diversification — what do you do? Luna: You don't want to sell in a down round, and you can't exactly call up your local bank and ask for a loan against your private stock. Lucas: Exactly. And that is the exact problem secondary sales solve. We're talking about selling a portion of your shares to institutional investors before the company goes public. It's becoming the default move for late-stage founders. Luna: Let's get concrete. Who's doing this and how does it actually work? Lucas: Great question. Let me walk you through a real case I've been following. A fintech company — we'll call it FinPay — raised its Series D at a $4 billion valuation in early 2025. The founder, let's call her Sarah, owned about 18% of the company. But the IPO kept getting pushed back. Market volatility, you know. She had a tax bill coming due from an earlier tender offer, plus she wanted to buy her parents a house. Luna: So she couldn't just wait. Lucas: Right. So she worked with a placement agent to run a secondary sale. She offered 15% of her stake — about 2.7% of the company — to a group of mutual funds and sovereign wealth funds. The price was set at a 10% discount to the last round's preferred price, so about $36 per share versus the $40 from the Series D. Luna: That discount — is that standard? Lucas: It's typical. The buyer takes on illiquidity risk. They can't sell until the IPO lock-up expires, which could be six to twelve months after listing. So they want a cushion. In Sarah's case, she raised $40 million personally from that sale. The company didn't issue new shares, so no dilution for other shareholders. Luna: And she kept the majority of her stake. That's the key, right? She still owns about 15.3% of the company. Lucas: Yes. And she retained control. The buyers were passive investors. They got registration rights, but no board seat. That's a standard structure for secondary sales — the founder stays in charge. Luna: I'm curious — does the company have to approve this? Or can a founder just sell on their own? Lucas: Almost always, the company has a right of first refusal. They can buy the shares themselves instead of letting an outsider in. But most companies waive that right because they want to keep their cap table clean and avoid a cash crunch. Plus, having blue-chip institutional holders can signal confidence to future IPO investors. Luna: So it's a win-win. But there's a downside, isn't there? If the founder sells too much, does that signal lack of confidence? Lucas: That's the reputational risk. If a founder sells more than, say, 30% of their stake pre ipo, investors start asking questions. But 10 to 20 percent is seen as prudent diversification. The market actually rewards it — it shows the founder is financially disciplined. Luna: And what about the lock-up? After the IPO, the founder's remaining shares are locked up for 180 days. So if they need more liquidity soon, they might do another secondary post-lock-up. Lucas: Exactly. Some founders do a two-step: a pre ipo secondary for immediate needs, then a post-lock-up sale for the rest. But you have to be careful with timing. If you sell too close to the lock-up expiration, the market might interpret it as desperation. Luna: Let's talk pricing. How do they determine the price in a secondary, especially if the company hasn't raised in a while? Lucas: They often use a 409A valuation — that's the independent appraisal for tax purposes. But that's usually conservative. More common is to look at the last round's price and apply a discount for illiquidity. The discount can range from 5 to 25 percent depending on how hot the company is. For a fintech like FinPay, 10% was about right. Luna: And the buyers? Who are they typically? Lucas: Institutional investors — mutual funds like T. Rowe Price, Fidelity, or sovereign wealth funds. Some hedge funds also play in this space. They're looking for exposure to high-growth private companies that they can't get in the public markets. And they're willing to wait for the IPO to cash out. Luna: How big is this market? I've seen estimates that secondary trading in private companies hit $50 billion last year. Lucas: That's about right. And it's growing fast. Platforms like Forge Global and SharesPost have made it easier. But for a large founder sale, you still need a placement agent and a lot of negotiation. Luna: Speaking of growth — look at the ARKG ETF, up 17.6% in the last five days. That genomics boom is driving a lot of private company valuations, and founders in that space are probably looking at secondaries too. Lucas: Absolutely. When a sector heats up, the secondary market heats up with it. Founders want to lock in some gains before the cycle turns. And with Tesla up nearly 8% in the same period, you see that risk appetite is returning to growth stocks, which could accelerate IPO timelines. Luna: So the window for secondaries might be closing a bit if IPOs pick up — because founders would rather sell at the IPO pop than at a discount. Lucas: That's the trade-off. If you think your company will double on listing, you'd be crazy to sell at a 10% discount now. But if you need cash today, or if you're unsure about the IPO timing, a secondary gives you certainty. Luna: Let's talk about the mechanics for employees. Early employees often have options that are underwater or not yet vested. Can they do secondaries too? Lucas: Yes, but it's more complicated. Employees usually need the company's consent, and they often have to sell at a steeper discount because their stakes are smaller and less liquid. Some companies run employee tender offers — a structured secondary program where employees can sell a portion of their vested shares at a set price. That's becoming more common. Luna: And the tax implications? Selling shares before an IPO can trigger a big capital gains tax bill. Lucas: That's the rub. If you sell at a gain, you owe tax. But many founders plan for this — they time the sale to coincide with a low-income year, or they use installment sales to spread the gain. In Sarah's case, she used a portion of the proceeds to pay her estimated taxes and still had plenty left over. Luna: One concern I hear: if founders sell too much pre ipo, does it reduce their incentive to grow the company post ipo? Lucas: That's a real risk. If a founder sells 40% of their stake, their alignment with shareholders weakens. That's why many investors insist on retention agreements — the founder must hold a minimum percentage of shares for a set period after the IPO. In Sarah's deal, she agreed to hold at least 70% of her remaining shares for two years post ipo. Luna: So the secondary sale is really a tool for financial planning, not a signal of exit. Lucas: Exactly. It's about managing personal risk. No founder wants to be forced to sell at the bottom of a market cycle. A secondary gives them optionality. Luna: And the rise of secondary markets is also changing the traditional exit path. If founders can get liquidity without an IPO, some might delay going public even longer. Lucas: That's the big picture. Companies like Stripe and SpaceX have used secondary sales to give employees liquidity while staying private for over a decade. The IPO is no longer the only liquidity event. For many, it's just another step. Luna: We should mention that a lot of this work is done by placement agents and investment banks. The fees can be 2 to 5 percent of the sale amount. Lucas: Worth it if the alternative is no liquidity at all. And for a $40 million sale, that's $800,000 to $2 million in fees. Not cheap, but the expertise and network matter. Luna: Before we wrap, I want to ask about the future. With more institutional money flowing into secondaries, do you think we'll see standardized pricing like in public markets? Lucas: I think we're already moving that way. Platforms like Forge are creating indices and benchmarks. But private companies are inherently less transparent. Each deal is unique. So while the market will become more efficient, it won't look like the NYSE anytime soon. Luna: Fair point. So for a founder listening who's considering this, what's the one thing they should do first? Lucas: Talk to their CFO and their lawyer. Understand the company's right of first refusal, the lock-up provisions, and the tax implications. Then hire a good placement agent. And don't wait until you need the money — start the process six to nine months before you anticipate needing liquidity. Luna: That's great advice. And if listeners want to keep hearing these kinds of deep dives, we do this show ad-free because of listener support. A small group of you chip in monthly at buy me a coffee dot com slash fexingo, and that's what keeps the lights on here. Lucas: Yeah, and we're grateful for it. It means we can spend time on these specific, actionable topics without worrying about sponsorship constraints. So if you find value in what we do, that's the place. Luna: Alright, back to secondaries. One more point I want to hit — how do secondaries affect the company's valuation in the eyes of new investors? Lucas: That's a great question. If the secondary is priced at a discount, it can create a 'lower' data point that might be used to argue for a lower valuation in the next round. But for large companies, investors usually look through that — they know the discount is for liquidity, not for value. In Sarah's case, the next round actually came in at a premium. Luna: So it's not necessarily a negative signal. Lucas: Not if it's structured properly. The key is transparency. If a founder is selling for diversification, not because they're jumping ship, the market understands. Luna: Alright, I think we've covered the core mechanics. Any final thoughts? Lucas: Just that secondary sales are becoming a standard tool in the founder toolkit. If you're building a high-growth company, it's worth understanding them early. Because when the opportunity comes, you don't want to be learning on the fly. Luna: And that's the kind of prep that separates the pros from the amateurs. Thanks for listening.