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Types of secondary buyers in the market

 

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Types of secondary buyers in the market

There are six major types of active participants in the direct secondary market:

1. Existing investors or the company Existing investors in a company or the company itself can repurchase shares from employees or other investors.

2. A primary investor
Many primary venture capital firms have struggled to provide attractive returns and meaningful liquidity to their investors and as a result have considered or began to explore secondary transactions.

3. Fund-less sponsors
Fund-less sponsors are participants in the secondary market who aim to identify shareholders seeking liquidity and negotiate a transaction with them.

4. Secondary exchanges Thanks in part to some highly publicized transactions in 2010 (e.g., Facebook, Zynga, LinkedI…See More

5. Megabuyers
A small group of players across the globe have been making the headlines with large direct or secondary investments in promising internet companies.

These include Digital Sky Technologies from Russia who has spent $800 million buying Facebook shares from employees;

6. Secondary funds
Broadly speaking, there are two types of secondary funds:

– direct secondary funds
Direct secondary funds are investment firms with dedicated capital whose sole mandate is to provide liquidity to sellers of private company shares.

– indirect secondary funds.
buy limited partnership (LP) interests in other investment funds and basically replace current investors in a fund.

Types of secondary buyers in the market

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There are six major types of active participants in the direct secondary market:
􀂃 Existing investors or the company Existing investors in a company or the company itself can repurchase shares from employees or other investors. For companies with substantial excess cash (ideally due to cash generation from operations), it may make sense for the company itself to acquire shares from employees or investors, similarly to the way public companies conduct share
buybacks. However, if the company is burning cash or saving cash for  acquisitions, this option may not be appropriate. Sometimes, existing investors may wish to increase their stake in a company. If the company is unlikely to need further capital (therefore reserves at the fund level are not needed) and the inside investor is prepared to pay a reasonable price, they can often be a good buyer of shares.

However, since the mandate of the primary investor fund is to provide capital for growth and other corporate purposes, the potential for significant secondary stake liquidation is often limited. Further, an additional investment
in secondary shares may limit the investor’s appetite in the future for growth capital or acquisition funding.

􀂃 A primary investor Many primary venture capital firms have struggled to provide attractive returns and meaningful liquidity to their investors and as a result have considered or began to explore secondary transactions. In addition, some investors may have tried to participate in a primary round with a company but lost out to another firm, and as an alternative route, they may consider investing through a secondary opportunity. However, since many primary
firms do not want to buy common or junior preferred stock, the number of primary firms actively pursuing secondary deals is limited.

􀂃 Fund-less sponsors
Fund-less sponsors are participants in the secondary market who aim to identify
shareholders seeking liquidity and negotiate a transaction with them. However, instead of financing the deals from an existing fund, the financial backing is arranged on a deal-by-deal basis. These agents or firms usually get compensated with a fee for their intermediary services and/or receive profit sharing after the eventual sale of the stake that was acquired
with their help. Sometimes funds will be formed by boutique banks that raise money from a small group of wealthy investors with a mandate to buy shares in one company. It is frequently the case that fund-less sponsors will provide an offer or letter-of-intent and use that agreement to raise money from a third party to consummate a transaction; however, the transactions often fail to close if these groups cannot raise the promised capital.
􀂃 Secondary exchanges Thanks in part to some highly publicized transactions in 2010 (e.g., Facebook, Zynga, LinkedIn, and Twitter), secondary exchanges have become well known as an avenue where private stocks can change hands. Examples of these exchanges are SecondMarket, NYPEXX, and Sharespost. However, these exchanges are limited in their ability to provide
information about the underlying companies and frequently charge additional fees associated with the transaction. In addition, secondary exchanges tend to focus only on a few highly publicized, “popular” companies. Transactions in these companies are executed

VC Investments and Liquidity Events

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Figure 1: U.S. VC Investments and Liquidity Events 2001-2009

As a result of this disparity, the direct secondary market has emerged as an alternative liquidity vehicle for investors and founders/employees of venture-backed companies, and it has become an important instrument for investors, companies and employees to address a variety of issues that they face.

While this booklet is specifically targeted towards venture capital-backed companies, many of the issues and dynamics discussed also apply to other private equity investment, such as buyouts and companies without existing professional investors.