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Continued economic volatility and a tepid IPO market in 2023 have many private companies exploring options for granting shareholder liquidity. While organized liquidity programs have become a popular way for companies to retain and reward talent and manage their cap table while growing privately, market volatility can impact if and when a company should address the liquidity needs of their employees.
We recently invited executives in The Circle to discuss their challenges and strategies for secondary liquidity and to get a pulse on private market liquidity trends from Erik Peña (Chief Revenue Officer at Nasdaq Private Market) and Mike Jung (Partner and Co-Founder of Founders Circle Capital).
[Note: if you’re new to the world of secondary liquidity, we highly recommend reading our Employee Liquidity Guide, which dives deep into the mechanics and potential outcomes of these transactions.]
Five Private Market Liquidity Trends in 2023
The record levels of secondary activity on the Nasdaq Private Market (“NPM”) in 2021 came to a screeching halt in 2022 thanks to widespread valuation markdowns, a significant gap between bid/offer spreads, and outsized seller demand. As buy-side interest waned, the need to preserve balance sheet cash may have also inhibited companies from conducting share buybacks for their shareholders.
In the second half of 2023, secondary trading appears to be rebounding, though not quite to 2021 levels. Erik revealed five key trends that NPM is observing across the private market landscape:
- Compression of the bid-ask spread – As companies resumed raising primary rounds in 2023, many have conducted follow-on secondaries, a common trend within private market liquidity. “About 70% of tender offers on the NPM platform happen within a few months of a primary round as a lot of the legwork around aggregating investor interest and performing diligence is already done,” explained Erik. In addition to providing broad-based liquidity, these follow-on secondaries often help guide pricing for one-off trading in the private marketplace.
- An uncertain IPO market – When the IPO market is performing well, late-stage companies may be less inclined to conduct a secondary immediately before going public. In 2022, the IPO market was completely anemic, and in 2023, the IPO window has barely crept open. Therefore, companies might still be holding off on plans to go public and looking to run a secondary to provide liquidity to their shareholders. Even companies with imminent plans to go public may be feeling unsure about how stock price performance during and after the 6-month post-IPO lockup period might impact shareholders.
- Secondary pricing at par with preferred round – As private market valuations soared in 2021, tender offers were largely priced at a premium to the last preferred financing round. In 2022, the opposite was true, where many programs were priced at a 20-30% discount. In 2023, likely as more companies have raised money at a down round or lowered their 409A valuation, median secondary pricing appears to be on par with the last preferred round. Erik noted that more companies are also conducting auctions that use market-based price discovery for buyers and sellers.
- Share buybacks on the rise – There has been a notable uptick in share buybacks facilitated using balance sheet cash. “Typically, share buybacks represent less than one-third of the transactions on our platform; in 2023, they’re about 50% of the transactions,” said Erik.
- Record levels of shareholder participation rates – There’s a pent-up demand for liquidity among shareholders, leading to much higher tender offer participation. “Participation rates usually hover around 50% of eligible shareholders; in 2023, they’ve spiked to 80%,” said Erik.
Market dynamics aside, secondary liquidity is becoming a recurring consideration for private companies. Liquidity pressure can start to build as early as Series A and compound as a company stays private longer. This is why it’s essential to think about your long-term liquidity stage, said Erik.
“Think of secondary liquidity as a continuum. You may have individual shareholders looking for liquidity from their employers or buyers in the open marketplace. Companies can let that pressure build or choose to run one-off or regular liquidity programs that allow them to set parameters around who can buy and sell and how much equity can be sold. We’re also seeing a growing contingent of companies looking to aggregate selling activity into organized trading windows with approved institutional buyers rather than running a liquidity program.”
– Erik Peña, Chief Revenue Officer at Nasdaq Private Market
Key Considerations When Planning for Liquidity
A poll of executives in The Circle found that the majority are open to granting secondary liquidity; however, they may be unclear when or how. Decisions around the timing and structure of a liquidity event should always be an ongoing dialogue between senior leaders and the board of directors.
However, sometimes an organized liquidity event may be a reactive measure, such as in one of these scenarios:
- More than ten vested shareholders are seeking liquidity – Mike pointed out that most law firms will recommend an organized tender offer in this situation, given the administrative work involved in dealing with one-off shareholder requests.
- Unauthorized trading impacts stock price – High volumes of secondary trading on third-party marketplaces can potentially impact pricing for future secondaries or the company’s next 409A.
- Employees with expiring options – Later-stage private companies may have shareholders brushing up against the 10-year option expiration window, forcing them to consider whether to let those options expire or go through the onerous process of canceling and reissuing them.
From a company size and growth perspective, there’s no firm threshold for when a company is “ready” to consider a tender offer. According to Erik, the concentration of tender offers on the NPM platform occurs within companies that:
- Have reached Series D+ funding
- Are $1 billion+ in company valuation
- Have 100+ employees
As previously mentioned, companies will often time a tender offer with an upcoming fundraising round to bring on new investors or replace existing ones.
Mike called out two important considerations during this process:
“As part of a secondary program, there’s an opportunity to recast your cap table, so it’s important to be thoughtful about how these new investors can be helpful to your company during its next phase of growth. Many companies will seek shareholders who will remain shareholders beyond an IPO, or investors who can bring value in other ways, whether that be through helping identify key executive hires, or helping with customer introductions, to name a few.”
-Mike Jung, Co-founder & Partner, Founders Circle Capital
Communicating With Employees
Employees will likely have questions about your company’s position on shareholder liquidity, particularly during economic uncertainty. A proactive communication strategy can help to manage employee expectations and quell some of the “water cooler” talk about your company’s stock price and valuation. If you’re planning to talk to employees about liquidity, be sure your communication strategy addresses the following:
- Timing and frequency of liquidity – It’s important to set expectations about the company’s philosophy on secondary liquidity so that employees know what to expect today and in the future..
- Who can participate and why – Being transparent about the goals of your liquidity program can help employees understand the logic behind who and how much any particular person can sell.
- Program mechanics – It’s essential that employees understand how the transaction process will work and what they need to do to participate. Clarity and transparency about the program mechanics can help encourage participation and minimize delays.
As market volatility continues, many growth stage companies are feeling added pressure to address shareholders’ liquidity needs. Understanding how broader market trends can impact buyer and seller motivations can enable companies to identify the right timing, program structure and communication strategy to deliver the best transaction outcome.
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