The New, Underappreciated Secondary Market - Cashless Transactions
If you told a founder or employee that the secondary markets should be larger and more accessible, none would argue.
And it’s true – there should be more opportunities to sell equity or equity-like positions for cash, in a startup world where illiquidity is a problem. Here at Aption, we firmly believe this.
But we also believe that there’s a larger, more critical way that the secondary markets should evolve. And that the answer may be surprising to most.
A cashless secondary market.
What do we mean by “cash-free” secondaries?
How does one sell secondary if they aren't selling it for cash?
They aption it. They exchange their economics, for those of similarly-promising equity positions. They enter aption pools, exiting one position and entering another, in a cash-free, tax-advantaged matter.
In other words, they are selling secondary. But they are selling it “in-kind”, instead of for cash. They are getting other equity positions in return.
What I hope to show is now just that equity pooling, or aption pooling, should be understood as a secondary sale.
This is more than semantics. Rather, aption pooling is a critical, under-appreciated secondary market. And it’s more useful than a cash secondary market, for the vast majority of founders and workers.
Not only can aption pools support billions of secondary transactions a year. But they should support them. That is because it’s the most rational choice, for the vast majority of equity holders.
Aptioning is the most useful and practical way for the vast majority of founders and employees to “sell secondary”. To realize and protect their equity wealth, in the near- and long-term. Regardless of whether they can access “regular” cash secondary opportunities, or not!
Illiquidity has gone from a “bug” of startup exposure to “full-blown sickness”
There are many companies that are private, but have semi-functioning or liquid markets.
Think of companies like Stripe or SpaceX. These companies are not publicly traded, but it doesn't take much effort to find a “0/0 SPV”, or structured transactions.
But for every company like OpenAI or Anduril, there are thousands of other, high-quality companies that are excessively illiquid.
These are not highly speculative pre-revenue companies. These are companies that might have valuations of hundreds or millions of dollars, tens of millions of revenue, and/or objective economic value. Companies with robust executive teams and impressive operations, that rival those of publicly traded businesses!
Yet, the founders, executives, and early employees of most of these companies have their hands tied.
Why is excessive illiquidity endemic, despite a mature VC ecosystem?
There are many reasons that equity holders at valuable companies are unable to sell their equity.
Oftentimes, the only investors willing to buy a stake in the company are the VCs.
Many VCS have a policy not to do secondary transactions, until the company has little to no risk of bankruptcy. Even a company that has raised many tens of millions of dollars might not find willing participants to provide a few hundreds of thousands of dollars of liquidity, if the investors in question don't have the reserves or the willingness to deploy capital for anything other than working capital for the company.
But, you may ask, why shouldn't a shareholder be able to sell this equity elsewhere?
The answer is that they are often throttled. Legally, or practically.
A non-founder does not have access to the kind of data that they would need to consummate a priced transaction. To share anything approaching sufficient data to facilitate a sale of their shares would involve a) access to information that they don’t have or b) a breach of confidence, or at least, political capital of the founder and board. They're putting their career in livelihood at risk, on the off-chance of protecting their illiquid position at what will probably be a below-market price.
Even the founder has substantial risk. If they were to sell cash secondary at series A or B, they take signaling risk upon themselves.
Because of current cultural expectations around founder (over-)commitment to massive equity exposure, they might impair the company's future fundraising. They also sacrifice political capital with their investors and board members.
Furthermore, divulging information on their performance could be particularly harmful to the company, at a time of higher exposure to competitive forces.
It’s also a distraction. Primary fundraising is already distracting enough and the burden of setting up a secondary event is meaningful
Then net impact is that most equity holders cannot set up secondary opportunities, for a variety of reasons.
This illiquidity has gone from “inconvenience” to “big problem”
It used to be that companies would IPO or fail in 5 or 6 years. 4-year vesting would align most employees across the life cycle of the company. Individual, failed startup journeys wouldn’t take a substantial portion of one’s career.
Nowadays, companies can stay private for 15 years or more. And remain promising until the moment of failure.
Founders and employees might have no opportunity to protect equity stakes that swell to 95% of their net worth and stay there for many years, before crashing back down and becoming worthless.
This is socially irresponsible and a failure of our ecosystem to serve the working families for whom this is a reality
No one is “acting badly”, which means we need new solutions – Aption Pools
There is not a particular bad actor who is forcing this. Even the VCs' reactions are natural.
If somebody capitalizes a risky business and doesn't have a large syndicate of external financing sources. It is reasonable to want to constrain the capital willing to buy equity in the company to being primary working capital, instead of providing cash liquidity
Yet, excessive financial risk for founders and employees alike remains the same. The lengthening journeys of startups and the negative implications remain the same.
And the nature of the problem begs the solution. A new, useful, sustainable, sort of secondary market. A cash-free secondary market. An “apples-to-apples” exchange system, for protecting and growing equity wealth, without compromising on the incentives to build great businesses.
Aptioning is more elegant than it seems
Here's the beauty of cashless diversification. It's actually a better solution than cash diversification, for most employees and companies.
If somebody owns 1% of one of an exciting, early-stage company, the paper worth of their position is worth no more than $1M.
But it's very difficult to accumulate a stake like this, as a non-founder. Usually, a worker at a very exciting early-stage company probably has a paper position worth just a few hundreds of thousands of dollars.
I won't understate how exciting such a position can be, but the promise of a great exit is substantially more. A company that earns a 50 or $80 million valuation with high momentum is earning that valuation because thoughtful investors think that it can be worth 20 times as much. From the perspective of an employee, it is not an exciting time to sell.
Yet, their financial overexposure is a reality. This position might be 95% of their net worth. They should reasonably do something about it.
So how can they have their cake and eat it too? Well, if they trade part of that position for similarly promising positions. Other objectively exciting companies that have also recently raised money at similar valuations from similar quality investors. They move out of binary concentration and into a safer and diversified position.
But one that is fundamentally a high-growth exposure, where all the other positions can also realize 10x returns in a matter of years, with a similarly-high likelihood.
Furthermore, by holding a diverse basket of positions, the employee might not achieve liquid cash right away. But they make their odds of having a meaningful liquidity event in the near term dramatically higher.
So when we back up and see what has happened. By diversifying similarly-promising companies, the employee has insured their equity position, instead of “selling early”. They’ve insured their upside exposure as well. Furthermore, their upside now includes a greater likelihood of sooner and more frequent exits. It is also more likely that their overall exits will be greater, than if they had not diversified
Furthermore, the exposure data is not an issue, unlike cash secondary. Non-founders don't need to worry about not being able to show data and financials. Founders don’t need to worry about distracting diligence processes that expose trade secrets and compromise political capital. Simple “like-for-like” transactions can happen via recent financings, people's personal networks, or using Aption’s algorithms. To achieve reasonable diversification against small or mid-sized percentages of overall positions, without compromising on information privacy
It’s the definition of an elegant “win-win”.
Cashless secondary is a critical tool for startup workers
In conclusion, the cashless secondary market is not just a new and valid model. It’s the most important one, for most employees.
There won't be cash opportunities to sell for a while, for the vast majority of employees and startups. Even at a valuable company.
Even though an employee may have worked at a business for 7 years and have a $3 million position at that business, that's worth 97% of their net worth. There are many macro factors that stop this from translating into liquidity. Those market features won’t change, anytime soon.
But there is nothing to stop a flourishing cashless market from emerging. One that can make it more likely for tech workers to have larger sooner and more frequent outcomes, while reducing stress.
As the secondary markets continue to evolve, amid an ongoing liquidity crunch, it's important to remember that reconciling the tension between what founders and employees want and what is available on the buyside is not just a matter of bull or bear markets. It’s fitting a “square peg into a round hole”.
Aptioning and cashless secondary will never replace cash secondary. Just like how it won't replace cash, secondary or believing in a business and going long on it.
But there is a discreet and critically important need in the market that aption pools can fill, in a way that nothing else can. The sooner people can understand this, the safer they are going to make themselves and those around them, on their journey to financial success and personal fulfillment.
Aaron is a Chief Investment Officer & Co-Founder at Aption. He's a long-time VC, having invested for Insight Partners and most recently, as a General Partner of Aleph.