Evolving Secondary Sales: From Founder Windfalls to Employee Retention Strategies
In the dynamic landscape of startup financing, a notable transformation is underway in the realm of secondary sales. Traditionally, these transactions have been avenues for founders to liquidate portions of their equity, often resulting in substantial personal gains. However, a paradigm shift is occurring, with companies increasingly leveraging secondary sales as strategic tools to enhance employee retention and morale.
The Emergence of Employee-Centric Secondary Sales
A prime example of this trend is Clay, an AI-driven sales automation startup. In May, shortly after its Series B funding, Clay permitted a majority of its employees to sell a portion of their shares at a valuation of $1.5 billion. This move was unconventional, especially for a relatively young company, as tender offers—secondary transactions allowing stakeholders to sell shares—were uncommon in such early stages.
Following Clay’s initiative, other burgeoning startups have adopted similar strategies. Linear, a six-year-old competitor to Atlassian powered by AI, executed a tender offer at the same valuation as its $1.25 billion Series C funding. More recently, ElevenLabs, a three-year-old company, authorized a $100 million secondary sale for its staff, valuing the company at $6.6 billion—double its previous valuation.
Clay’s commitment to this approach was further demonstrated when, after tripling its annual recurring revenue to $100 million within a year, the company announced another opportunity for employees to sell stock. This time, the valuation stood at $5 billion, marking a significant increase from its $3.1 billion valuation just months prior.
A Departure from Past Practices
At first glance, these secondary sales at escalating valuations might evoke memories of the 2021 market bubble, where founders capitalized on high valuations to secure personal wealth. A notable instance from that period is Hopin, whose founder, Johnny Boufarhat, reportedly sold $195 million worth of stock two years before the company’s valuation plummeted from its peak of $7.7 billion to a fraction of that amount.
However, the current trend diverges significantly from past practices. During the era of near-zero interest rates, many secondary deals primarily benefited founders of high-profile companies. In contrast, today’s transactions are structured to include employees, reflecting a broader distribution of financial benefits.
The Strategic Rationale Behind Employee-Focused Secondary Sales
Investors and industry observers view this shift favorably. Nick Bunick, a partner at NewView Capital, a venture firm specializing in secondary transactions, noted, We’ve done a lot of tenders, and I haven’t seen any drawbacks yet. He emphasized that as companies remain private for longer durations and competition for talent intensifies, offering employees liquidity can be a powerful tool for recruitment, morale, and retention. A little liquidity is healthy, and we’ve certainly seen that across the ecosystem, Bunick added.
Clay’s co-founder, Kareem Amin, echoed this sentiment, stating that the primary motivation for providing employees with liquidity was to ensure that the gains don’t just accumulate to a few people.
The Competitive Edge in Talent Acquisition and Retention
Fast-growing AI startups recognize that without offering early liquidity options, they risk losing top talent to public companies or more established firms like OpenAI and SpaceX, which regularly provide tender sales. By allowing employees to convert equity into cash, these startups not only reward their teams but also position themselves as attractive employers in a competitive market.
Potential Implications for the Venture Ecosystem
While the benefits to employees are evident, some industry experts caution about potential unintended consequences. Ken Sawyer, co-founder and managing partner at Saints Capital, a firm specializing in secondary transactions, pointed out that while employee tenders are positive for staff, they enable companies to stay private longer. This extended privatization can reduce liquidity for venture investors, posing challenges for limited partners (LPs) seeking returns.
Sawyer elaborated, It is very positive for employees, of course. But it enables companies to stay private longer, reducing liquidity for venture investors, which is a challenge for LPs. In essence, if LPs do not see cash returns, they may become more hesitant to invest in venture capital firms, potentially disrupting the funding ecosystem.
Broader Industry Trends and Considerations
The shift towards employee-focused secondary sales is part of a broader trend in the startup ecosystem. Companies are increasingly recognizing the importance of employee satisfaction and retention, especially in a competitive talent market. By providing liquidity options, startups can offer tangible rewards to their teams, fostering loyalty and motivation.
However, this approach requires careful consideration. While providing liquidity can enhance employee satisfaction, it also necessitates a balance to ensure that the company’s long-term financial health and growth prospects are not compromised. Companies must weigh the benefits of immediate employee gratification against the potential implications for future funding rounds, valuations, and investor relations.
Conclusion
The evolution of secondary sales from founder-centric windfalls to employee retention tools signifies a maturation in the startup financing landscape. By aligning the interests of employees with the company’s growth and success, startups can build more resilient and motivated teams. However, this strategy must be implemented thoughtfully, considering the broader implications for the company’s financial strategy and the venture ecosystem at large.
