Carta held a panel discussing secondary transactions at our CFO Summit in May. The head of our corporate business team, Alessandro Chesser moderated the discussion. Panelists included Larry Albukerk of EB Exchange, Adam Kosmicki of Getaround, Justin Lau of Mixpanel and investor Ken Wallace of Industry Ventures. Below is a fee highlights of the panel with transcripts.
Larry Albukerk has over 20 years of experience in secondary programs. His current company helps provide cash liquidity to late-stage private companies.
Adam Kosmicki is the CFO of Getaround, an 8-year-old peer-to-peer car sharing company. Before Getaround he worked for a publicly traded asset manager.
Justin Lau was the legal voice at the panel. He is the VP of legal at Mixpanel where he has lead multiple secondary transactions.
Ken Wallace is the Managing Director of Industry Ventures. His firm is a liquidity provider that invests its $500 million fund in buying secondaries and LPs.
More from the Summit:
To see Slack’s Allen Shim in a fireside chat with Carta’s CFO click here.
To see the address given by Stephanie Gantos of Degreed click here.
To watch Eileen Treanor’s talk about Lever at our CFO Summit click here.
What triggers a secondary?
Alessandro Chesser: I have a list of questions here. I’d like to kick it off just by asking very general questions, since you all have very different backgrounds. What type of things have triggered secondary transactions that you’ve been a part of? From the very beginning, when the first discussion comes up, what usually kicks that off?
Larry Albukerk: Well my perspective will probably be different from a company perspective or a fund perspective. Most of the people we talk to, secondaries we thought of because they were leaving the company, they had tax issues. They had that 90 day issue of they’re going to leave, they’re going to lose their options. They don’t have enough. A lot of times, they do have money to actually exercise stock, it’s the paying the taxes part. If you have ISOs for example, it triggers an AMT tax. If you’re in a very successful company, there’s a little bit of a curse that, yeah, it costs $52,000 to exercise 8.9 million dollars worth of stock, but the problem was then you got a 2.6 million dollar tax bill and that’s the part where you can’t go to your mom or dad and ask for a loan, typically. I talked to a client yesterday who did a transaction in a company a few years ago, they were very hesitant to allow any secondaries. I got to know the general council, he got comfortable with it. One of the co-founders sold, he gave us a few other people.
Then the general council contacted me yesterday and they’re bumping in to a 10 year option problem, which I don’t know how many people know, but ISAs only last for 10 years. Then what do you do? If your company’s been around for a long time, you got a problem and those loyal people who have stuck around for 10 years or more lose their option. Sometimes that triggers it. Liquidity, people leave. There’s a lot of different reasons.
The last one is pretty popular for us. It’s just early investors, seeded investors who, they’re in it for the seed. 10 years ago they would have just sold as a public company, because they would have gone public after four or five years. Now they got to recycle their cash so they can see their 20X, a 10X, a 15X, it’s a rational time for them to sell.
Adam Kosmicki: From the company perspective, we’re at a stage where we see and I see most of our secondary interest in employee turn over, so that 90 days end tax. The larger secondary picture from the outside investor perspective and particularly preferred shared secondaries. The way I view it, which is heavily colored by wherever it is in its life cycle, is that you really start seeing a lot of interest in secondary sales, so existing investors wanting to monetize their position or at least some of it, post-inflection. It’s an interesting indicator of how investors who you might not talk to every day or even every quarter, view where your company is.
When those really early ones start calling and saying, “Hey, is there a way to sell some of this?” It means that your evaluation’s starting to get point where people are excited about where you are and not just where you’re going. For better or worse, getting around is sitting right in front of that. We just closed our Series C, which is our first expansion capital. There is an outside interest, because we kept things pretty close to the best around quietly. There’s a lot of strategic influence in it, it’s a mobility company, not automotive. That’s essentially part of the world right now. We’ve had a lot of inbound interest in the last few weeks in particular, but not a lot of people ready to sell. It’s sort of an ongoing thing that we feel like we owe our employees to create a way to do it. The investor that preferred equities, it’s a very different student set and had some very interesting signals and locations for the outside market.
Who determines the price?
Alessandro Chesser: You both just touched on a very important part there, price, and the potential impacts that it can have on your subsequent valuation, which actually segues directly into my next question, which is regarding price, which I wanted to direct toward Larry Albukerk. On the deals that you’re a part of, how is price determined, and who determines it?
Larry Albukerk: That’s the $64 million question. Well, hopefully it’s the 64 million dollar question. Thought you should.
Ken Wallace:You have a $64 million secondary?
Larry Albukerk: No. Are you buyers?
Ken Wallace: Depends.
Larry Albukerk: So, without beating around the bush, that’s the number one question every seller always asks, and that every buyer always asks, and that’s the part that we try to manage. But as an intermediary, I think a lot about this. So, there’s a buy-side perspective, there’s a sell-side perspective, it’s a very deliberate market, there’s not a lot of information, so how do you get bid ask price to match in a liquid market? Well, the way we think about pricing is, there’s a couple of guideposts, there’s 409A, there’s the last round. You can use a more fundamental approach for the later stage companies, that are about to go public, people know their revenue. You can look at revenue multiples or just more traditional ways. But for the most part, 95 percent of what we do. And then, of course, the other one is, companies that are heavily traded, like Facebook was in the day, that triggered more than a lot of public companies, I think, before it went public. But nobody cares what the fundamentals are, what the last round price is. It was $32.50? I’ll give you $32.75. $32.75? Do I hear. And that’s how that worked for Facebook and Twitter to a certain degree.
But usually the deals that we get involved with mostly are Series C, Series D companies, wherea buyer wants to pay less, the seller wants more, and how do you come up with a deal? And then, also you have to look at if it’s an investor. A preferred investor selling a Series D that is $19 a preference, versus a common, which is under 6 hundred and forty million dollars of preference, those are 2 very different prices for the same stock, unless you know it’s gonna go public tomorrow, or no ratchets.
Anyway, long story is that if you’re selling common, you have to look at the waterfall. Is it a likely M&A? Because if they’re gonna get acquired, you go through that waterfall with common unless it’s a very high price, will not convert to the preferreds would convert to the common price, and in an IPO everybody converts, but there might be ratchets, which is a pretty common thing. So a lot of things to think about. But at the end of the day, it’s what a buyer and seller both agree to, is the answer.
Alessandro Chesser: So you brought up stages of companies here, Series C, Series D, and I know for you and Ken in particular see a ton of these transactions. What is the typical? Is there a typical profile as in mainly unicorns that are doing secondary transactions or are you starting to see earlier stage companies doing them?
Ken Wallace: I think, what are the types of companies that are doing secondary transactions? Everybody’s doing secondary transactions, and so, for us, we typically don’t traffic in the companies that are retail names that are really well known unless we can get exposure to those a little earlier. So we’re in a lot of those companies like Facebook, Uber, Twitter, Ali Baba, but we got into those at a much earlier stage, and for us, we’re not taking market prices, we’re trying to drive market prices, so finding deals ourselves in companies that we know will exit preferred in 2 to 3 years, but we have a 500 million dollar fund so these are different transactions than maybe the smaller employee transactions, where you’ve got a couple hundred K that you need to exercise for your options.
For us it ranges in companies that have a minimum, I think, of 15 million in revenue, all the way up to companies that have hundreds of millions in revenue that are about to go public. But let’s say we typically stay away from companies that are bid up on valuation in private markets.
What does it cost?
Alessandro Chesser: So, next I’d like to jump back to the company side. When a company decides to do an employee liquidity program, what do costs and fees typically look like, and who fronts the bill. Is that the company that fronts the bill? Do you pass it back to the employees? How does that work?
Adam Kosmicki: So, there are a number of questions in there. From an employee standpoint, if you do it right, there are some up front costs that basically get amortized over every transaction. So there’s a pretty standard transfer agreement. There’s a standard set of back end stuff that’s imported, for one of the big things for Getaround is Carta. So paying for and onboarding onto Carta was onboarding in particular is an investment, because I don’t imagine Getaround’s unique in not being completely scrubbed off the shelf cap table and all the supporting documents and all the supporting email addresses and phone numbers for everybody.
So getting ourselves really scrubbed and clean so that you can open online, on-demand access to the company’s entire capitalization, that was an investment. Getaround, I take the perspective, the company really should bear those sort of, putting the foundation in place that you’re offering to employees. The tax advice we can’t and wouldn’t cover, stuff like that. Depending on the size of the transactions, some former employees or others would have their own legal counsel, so that would be borne by them. I kind of view it as very similar to a mini equity round. So the company’s got corporate counsel, corporate stuff, data, and things like that, that we’d have to set up, that concept, we bear.
The investor’s counsel and tax opinions and stuff leave for the individuals. From a investor’s secondary or preferred secondary’s it’s a little bit different. That one I would push, at the risk of being blunt in a big crowd here, I’d push every possible cost to either one of the investors, that this stance on the company, being a company that people want to invest in, which also means, being able to get your money out. But there’s not a ton of value for any other shareholder in that transaction, so we really try to off-board as much of that as possible.
Justin Lau: I think that makes sense, when you’re referring to the daily transactions in the secondary market. I can speak, specifically, to when you have an appropriate third party that comes in and purchases a big clump of shares, we structure in the tender offer, in that instance, we also pushed about 75% of the cost on to the third party purchaser, which ended up just being held E for our primary investor, so there’s a large amount of cost that goes into that when you do get another offer. Carta was terrific in helping us minimize that.
We did it twice, once without, once with, and I think we probably saved 75% of the cost. But, of course, there are some substantial up front legal costs in drafting things like risk factors and putting together the tender offer, that quotation, but it’s all upfront stuff, so you don’t have to do it again, like Adam indicated, so I think you shouldn’t push that cost as much as you can on the third party. You may not always win out, especially because you’re getting benefits to your employees, so in our instance it worked out pretty favorably but I’d caution that I don’t think we’d always give that position.
Alessandro Chesser: And to touch on that a little bit more, since, especially with your background being on the legal side, how much administration work is typically required, or how much help is required from your law firm when you’re putting together a structure with one of your programs.
Justin Lau: There’s a fair amount of work, if you don’t use an automated platform, it’s made worse, like I said, but I think you can expect that you’ll get a $25, $50K of costs if you’re working with one of the big firms and, having come from one, they charge too much, so to the extent that you can bring some of that extra piece in house, for us, luckily, I have done so many of them, and I told them what to do, but I think the normal instances you could expect a fair amount of legal bill for the tender offer documentation, but once you get that, the maintenance shouldn’t be hard, given if you use the network charter platform.
What are the rules?
Alessandro Chesser: For an employee program, how are the parameters typically determined like who can sell and how much they can sell? And what’s your strategy behind that?
Adam Kosmicki: I imagine this differs between buying team and company. Our philosophy is, you really shouldn’t put any parameters around that. It’s wildly unfair to decide who’s able to sell, who’s not unless you are very very clear about from when you hire somebody that, “Hey, you can’t sell if you’re a part of the company.” Maybe on the executive level it’s a little different but, see, we don’t really put any parameters around- There’s a bit of a, “If you’re catching my team at a bad time I might not be able to help you for three weeks,” and recently I had somebody who wanted to sell some shares to fund their daughter’s wedding. The guy was hugely motivated to get something done, get something done. I said, “Okay. We can buy your shares back for you at a third of what I can get you if you wait three or four weeks until we close this transaction.There’s a pool, your buyers are going to buy at 3X what you’re trying to sell,” and so there’s a little bit more communication to try to connect everybody on both sides.
On the buyer’s side it’s very, very different. That we are enormously hawkish over. Whether or not we should be may be up for debate but we’ve been lucky to connect … We’ve only had one new buyer since I’ve been around for the last year and a half. Everyone else has been internal investors, existing investors that want to pick up more shares, which is a really nice way to keep your seed investors engaged. You don’t typically see former employees have the kind of cash to buy more shares when they’re gone. Sometimes you get existing employees who have outside money or additional money on their own and they want to pick some more up, but typically it’s the seed investors – we’ve got four or five – that even want the first email every time shares come up.
So, that’s a neat little marketplace clearing that once you build a relationship with your investors you can promote that. But anybody who you wouldn’t want to have to pick up the phone and discuss the company to, they’re not going to be allowed to purchase shares, that’s probably the bar that we hold tight as teeth.
How is it talked about?
Alessandro Cheeser: How do you communicate the entire process to your employees? I imagine that’s very difficult, specifically around taxes and any other implications they may face and I imagine Ken also has some insight into that as well since he sees so many transactions.
Adam Kosmicki: Just at eye-level, communication is extraordinarily difficult. This is one of the hardest things that I’ve found in terms of talking to our employee base, there is a hugely disparate level of understanding of what this stuff actually is, how to value it, what the mechanics of it are and there’s a hugely disparate sense of what it’s worth to individuals across the company, so we try to communicate mechanics first so that people understand how this stuff works, and then try to give a sense of what this might mean to them.
There’s a balance of not giving tax advice and not giving investment advice that I’m maybe a little too scared to cross than I’d ought to be, but it’s a massive challenge and we try to just lay things on the table and then have one-off conversations, the door is always open so to speak, to talk about how should individuals think about that, because you can’t cram down a thought process on a board.
Justin Lau: Yeah, we did this recently. Communication is absolutely critical. I think what you typically would do, well, what we did, I think it worked out well. We had an all-hands meeting to describe the nature of the transaction in a broad bubble, it’s on the drivers of the transaction, and you alert people that things are going to be sent to them for review. We then held a series of what’s called ‘Office hours with the legal team and finance team and the finance team in which we pull in on some frequently asked questions and prepare.
Why don’t some companies have it?
Alessandro Chesser: So I think Ken Wallace brought up the point earlier about all companies do secondaries and think it’s a very valid point, but from my perspective, all companies do not do structured employee liquidity programs. I think one example, that I may be wrong, but I think Uber doesn’t really have a program for their employees.
Why don’t more companies that can, that obviously have increases in fair market value, why don’t they do more structured liquidity programs for their employees? What are they trying to avoid in opening up those programs?
Ken Wallace: I think they’re trying to avoid what happened to Facebook. I think they’re trying to avoid having too much stock in the market and having this turnover in the cap table. But also keeping the employees incentive, this kind of refers to what I was talking about keeping employees incentive where the ultimate outcome, I think some of these cases where they’re restricting the secondaries they want to make it so employees have to stay in order to monetize in their stock eventually. But from our perspective, it doesn’t make a whole lot of sense.
I think the best way to incentivize people is to make them happy to relieve the pressure that they feel for an ultimate exit. Companies that continue to push out that ultimate exit, it makes a ton of sense to have that liquidity. We like to come into the front door and talk to the companies, you know, usually we’re invested in the company already, they’re one of the buns that we’re in so we can have that exposure to the companies at the board level and really help them, talk through this conversation about “why are you blocking secondaries?” Is that what makes sense? I mean, we’ve gonna come in and the same strategy as you’re two guys or your board because we’re all aligned with those guys, but extend the runway for you as a management team to get the ultimate exit two or three years down the road.
But you know, even in cases where companies are blocking transactions, there’s ways around that. We don’t do the structured loan liquidity programs but others do. And then often times we’ll find investors like venture funds will have SPVs and then transfer within those SPVs so like I could by an LLC interest in a SPV that owns stock in a company that might be walking transfers, or I could buy an LP out of the fund as a way to get liquidity to some other investors and get exposure to the company. So there are transactions that are happening in these companies that are restricting at time periods, it just doesn’t happen at the direct level.
What is the impact of on 409A valuation?
Audience: You may have covered this earlier on and I think I just missed it, but what about the impact of secondaries have 409A? Did it have an adverse affect?
Larry Albukerk:That’s a great question. We get that question all the time, especially companies care about it. So I’ll give my 2 cents and then you guys can definitely have yours.
My thought on that is, and what we’ve heard from a lot of companies and 409A providers, is that if it’s one-off arm’s length transaction, it shouldn’t really matter. If the founders own 30% of the company, sure, it’s gonna matter, but if it’s an ex-employee, no longer works there, it’s 1.2 million dollars and the company has at market capital 1.8 billion on the last round, it’s not gonna affect the 409A. If the company has their fingers on it and they’re providing information, running the process, and it’s a program, yes, it probably does.
If it’s part of the round, if the round is priced at 5 dollars and they buy-back’s at $5, yeah, it’s, you know, a lot of times the 409A, you know, but it’s up to the 409A firm that writes the report is generally what we’ve heard. But it’s still a little wild west and you know, then there’s certain exemptions you can get, if it’s strategic you get a discount. But it is something that a lot of companies are worried about, particularly the first secondary that the company ever dies, it’s how’s this gonna, we don’t want to do this, it’s gonna effect out 409A, well, truth is it probably doesn’t if it’s a third party transaction gone blank but if it’s company sponsored then it probably does.
Ken Wallace: Yeah, we have an article on this on our website industryventures.com. There’s a bunch of articles there, in particular 409A, check it out. But I think that’s the crux of it is that the closer the company is to it, the closer the board members are to the transaction, the more it’s gonna affect the 409A. So the more distance you can get from it, that’s part of the value that we provide is that we’re an independent third party, we don’t need a whole lot of interaction from the company. We have a lot of this information in our database already. It’s not really gonna affect it that much.
Audience: Just real quick to follow up, why is it that third party doesn’t effect it as much, because I would think a third party is setting a market price for it whereas inside investors and already investors buying it, it’s sort of like an inside deal to try help out the early stock holders. So why is it outside?
Ken Wallace: Because we might not interpret that information, it’s not a process that the company is running, it’s a data point that the valuation professionals will use. But they’re going to focus on other data points.
What are the restrictions?
Audience: On the topic of individual secondary transactions, can you give us a sense of the type of transfer restrictions that companies put on them and how some companies will waive those restrictions? What are the trends?
Larry Albukerk: I see a lot of those trends happening all the time, and five six years ago there were no restrictions, you just traded. And then maybe it started five or six years ago, now there’s a lot of restrictions. And there’s a lot of companies that the first option plan had no restrictions and then they did the first company buyback and party of that buyback was adding incentives saying “oh yeah, by the way, the board has to approve any transfers.”
So that was the first wave and a lot of the bigger, the first kinda unicorns, first wave or second wave, whatever you want to call it, about five six years ago started implementing those a lot. And now it’s very common. And it’s kind of split and they have rules, and some have some hybrid model. But once a company hits a certain size, they think about it a lot and I think that that’s what, once there’s a program in place, they’ll have more restrictive language if you participate in that program.