Exploring Secondary Direct Investments with Andrea Walne of Manhattan Venture Partners

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With an abundance of capital chasing a limited number of opportunities, one unique entry point for investors is in secondary direct investments. Secondary opportunities consist of buying shares in private, pre-IPO companies directly from employees and investors versus the traditional route of participating in the next round of fundraising.

Andrea Walne is at the center of this world at Manhattan Venture Partners (MVP), where 80% of their investments are in late-stage companies by buying secondary investments. Andrea and her team are focused on tapping into the value that already exists. Formerly a founder of Forge Global, Andrea has worked with over 100 late-stage private companies and has facilitated over $10 billion worth of transactions. On this episode of The Modern CFO, Andrea shares insights on this growing market segment in VC, its evolving landscape, and the opportunity for liquidity it presents.

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Key Takeaways

3:20 - Build a secondary position

Instead of fighting to issue a term sheet and compete with late-stage investors, MVP uses its network of relationships to enter a business at the ground level.

“We're on our fourth fund right now. With our strategy, it allows us, strategically, to pinpoint how we want to enter a business that we're interested in. When I say enter a business, we're not fighting to issue a term sheet and compete against other late-stage investors to lead a round of funding. What we are doing is generally considered “friendly” to many of our counterparts in the late-stage venture community, because we are figuring out a price point and identifying, by way of our network, (who all knows the partners of our firm really well by way of our experience); We find our way in with a certain price point and we're able to dollar cost average and choose that building of a position by way of the secondary. So, it's pretty awesome. It allows us to choose what valuations make the most sense for us.”

6:33 - The changing environment of common stock

Common stock used to be considered a risky business. Today, it’s easier to assess if a company—and therefore its common stock—is valuable early on.

“I've never seen a world where a company can raise a round of funding and be a mid-stage or late-stage company. I do say mid-stage, because I think it's important. A company will raise a round. It's typically oversubscribed—most companies are raising oversubscribed rounds. There's a ton of capital flowing in and immediately after the round is raised, we're working with issuers and their shareholders who believe that their stock is immediately worth a premium to that round, immediately after the round is closed. Precedent will tell you that, historically, you could see that common stock, which is issued to the employees of a private company, versus the preferred stock, which is issued to the investors when they invest, the common stock is usually priced at a discount, because there's inherent risk associated with common stock. God forbid there's ever a bankruptcy in a private company, the common stock gets paid back last after all the preferred stock and any debt. So, there's inherent risk associated with common stock. If you go back three to five years, 20-25% discounts for common stock were normal relative to the latest round of preferred financing. For the environment to change so rapidly is absolutely fascinating for us.”

10:03 - The danger of taxing unrealized gains

Congress has floated different options for taxing wealthy figures, like Jeff Bezos. The problem is the potential for harmful trickle-down effects that could negatively impact budding entrepreneurs and their early employees.

“Something that seems like it comes up in Congress quite often is just taxing unrealized gains. That alone is constantly brought up and constantly talked about at both the gains-perspective and then deeper on a carried-interest perspective, which is obviously gains earned by way of the profits to venture capitalists and those that are investment managers. Overall, what I will tell you is that the resounding theme across all of these proposed changes and contemplations is that clearly Congress is looking at the folks like Jeff Bezos, Elon Musk, Mark Zuckerberg, and the upper echelon of the tech community as being the only population that really matters. The more that Congress can better target them and tax them for their wealth, which was in my mind earned wealth, quite well-earned wealth, is something that I feel is so shocking, because I don't think Congress realizes how that permeates down to those who are really the rank and file working at tech companies. Employees these days are given stock options at private companies. That doesn't mean that they own the shares outright. A stock option simply means they have the right to exercise, AKA pay a cost, to then own common stock shares in a private company. For there to be a concept of taxing unrealized gains when there hasn't been any form of a sale, where there's any gain to be had or money in the bank, it's just constantly shocking to me that that's even a consideration. It's something I worry about..”

15:44 - Successful startups are impossible to ignore

Many startups today are coming out of the gate with incredible growth and high value.

“As much as we all love working with institutional folks, school endowments, pension funds, fund of funds and the like, there's a bit more of a disconnect when you're working with an institution that has a bit more of a regimented strategy as it relates to their venture asset allocation. The passion comes from the family offices and so, when we speak to our LPs, we see that they're all seeing startups more and more and more in the news. What I think has really shifted in the last five or six years has been that you're now seeing startups with bigger market caps than any company listed on the Nasdaq or New York Stock Exchange. So, it's impossible to ignore these startups, because they're bigger by way of market cap and size and growth than most listed businesses. That shift means that startups are in the news every single day. There's a new $10 billion minted company every single day, which is shocking to hear. It used to be that seeing a billion-dollar valuation four years ago was fascinating.”

21:41 - The impact of media exposure

With large private companies doing so well, they also get a huge amount of media coverage. That means that determining facts about their financial profile is easier than ever.

“The biggest private companies these days are actually getting more exposure in the media than most public companies are, which is really fascinating. It's because they're just so big, they're so innovative, they're breaking rules, and they're making change. With all of that, they are getting more media exposure. With media exposure comes people who are covering them and digging into the company's analytics, digging into the company's financing history, revenues, and growth. There's a lot more of a spotlight on that and late-stage private companies these days than there ever was. Coupled with the concept of vast transparency, companies aren't as hidden as they were five years ago as it relates to their growth. It's also very competitive out there, right? Companies are all competing for talent. They need to be able to go out publicly and say: ‘we're the best in our space.’ They're doing this because it's a signal to potential recruits to say: 'look at how big we are relative to our competition.' So along those lines, it doesn't take much these days to actually find sources that distill down a company's financial profile.”

25:09 - Private startups benefit from closed doors

Private companies looking to issue stock have an advantage of insularity and control. For investors, that means it’s important that the cap table is properly managed for accuracy.

“On the platforms, just to kind of go back to that concept, we're talking about Carta, Forage, Nasdaq, there's a bunch of them, Zanbato.. At the end of the day all of them are trying to effectively reflect, and trade, and transact in an asset that has a lot of governance control by the issuer itself, and is not controlled by way of a transfer agent, market maker, or exchange. With that, the companies, the issuers themselves, these private startups are really benefiting from having kind of closed-door access to their equity and their ownership. Because you know what, they have the right to do that. They have the right to be very insular in terms of how they manage their investor base. Knowing that, the struggle that I think every company that is building software in the private market, kind of trading or cap tables or investment management space is kind of looking through is, well what is the source kind of information for all of this equity or the legal documents that govern the ownership of an asset? A piece of a unit. And when you're talking about a private company's cap table—and a cap table is a ledger that reflects ownership of investors and shareholders and otherwise—if that ledger isn't managed properly and kept updated, you really can't do much with that information.”

29:56 - The catalyst for secondary investments

When Andrea’s friend Sohail Prasad found himself stuck at a company with “golden handcuffs” thanks to equity benefits, he and Andrea started brainstorming ways to cash out the value of his stock prior to IPO. The result was Forge Global.

“He, kind of secretly, was begging he would get the layoff package, so that he could go build a new startup. And that never happened. He never ended up getting terminated as part of the layoffs. So with all that, Sohail and I brainstormed and said, 'Well, what if we could just sell your Zynga stock before they go public in some way shape or form, and get your cash and then we can go build something cool?' We really dug into it to find out just how difficult that idea really was, selling your private company startup stock before a traditional IPO. So we started really thinking about what it would take, and overall we said, we're going to have to come up with an instrument to trade or transact in these private securities, because it's so difficult to trade the underlying stock itself, that underlying startup employee stock.”

33:56 - The overabundance of capital in the private markets

Secondary investing is becoming more common because funding rounds are oversubscribed. It’s a strategy that makes sense for many founders, whose energy and finances are often stretched thin.

“Over 50% of Series B rounds now include a secondary component and it's not necessarily limited to the founders. It expands to some of the early employees, or maybe even Angel or seed investors who had just had stuck with the business and needed a little bit of cash because they were the founder’s mom or dad, or something similar. I do absolutely see the trickle-down, but I would say it's really predicated on the fact that in today's world, Series A and B rounds are getting oversubscribed. So, the activity that's happening in 90% of instances (and this is all based on the data I had been reviewing) is that it's really the secondaries that are happening. Because the rounds are oversubscribed, the company doesn't want to take on any further dilution. So, the founders look in their pockets and say, 'What else can we offer to the investors we do want to bring on as partners?' And they ended up offering a portion of their own stock. I don't blame them because these founders usually take huge pay cuts to build their startup for the first few years.”

35:14 - Liquidity is no longer a necessary sweetener

Founders offering stock to investors used it as a carrot dangled in front of them to get them to invest. Today, it’s more about getting an infusion of non-dilutive capital.

“You go back three years, and if I saw liquidity in a Series A or B, a lot of it was more of a sweetener than anything else. And when I say that, it's that a company was raising money. They wanted to bring in some really strategic investors and as a way to get better terms for those investors, they would offer their own kind of founder stock or employee stock at a discount to the Series A or B or C as, like I said, a sweetener. Now, that has really shifted to not being a necessity in the best companies. Instead, it's a volume point that's brought up later, as a way to get more capital in that is non-dilutive in its function.”

37:52 - A new world means new investment strategies

Today, Andrea is captivated by the changing ways that families are investing. Buying a piece of real estate is no longer the silver bullet it once was.

“I am fascinated by the changing dynamic of family lifestyles, and how people want to be in multiple places at the same time, and quite frankly, how in today's market, owning real estate really isn't any more of the best investment strategy as part of a family's overall gross income and value. It really isn't. We're at the a ‘top of the market’ kind of focus here. People are exploring other avenues for investing strategies because, as we are talking about, tying into today's theme, the democratization of investing is happening rapidly around us. People don't need to buy a house to say that that's going to be their highest grossing asset over time. So, what I get fascinated about in today's world are companies like Pacaso, which is a startup, and Feather Homes, which is a startup, that you get to rent furniture by the month that gets delivered to your nomadic lifestyle. Pacaso was started by the guys who were in the real estate firms at Redfin who said, 'Let's do fractional ownership of mega homes.' Why dump all of your net value into one home? Instead, let’s pool it together, and you can own an eighth of an amazing luxury home, and then you could sell that eighth.”

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