VENTURE capital (VC) investing should be relatively simple: You hand money to a new company to help it grow in exchange for a stake in the business. After a few years, once it is established and able to turn a profit, you sell your interest in an initial public offering (IPO) or a buyout, yielding a multiple of your original outlay.
Recently, however, the VC business model has come under strain. It is taking longer than in the past for startups to scale up and turn profitable. And even when they do, some founders choose to keep their business private as they find the potential valuation boost that comes with an IPO is not worth the additional scrutiny required for a public listing.
The result is that a lot of VC fund managers are having to wait longer to capitalise on their investments, repay their own backers and plough cash back into other promising opportunities.
Those who prefer not to hold off have been turning to the “secondary” market, a venue for buying and selling stakes in a growing array of private companies. The market has existed in some form since the late 1970s, but has mushroomed lately. An estimated US$122 billion in assets are expected to change hands on the secondary market in 2025, up from US$25 billion in 2012, said VC firm Industry Ventures.
In the past, the secondary market was seen as a last resort and a rather expensive option for investors to offload stakes in a hurry. Now it has become almost a feature of the VC investing process. Sam Lawson, a founding partner at Flywheel Capital, said the idea of buyers on the secondary market as mostly distressed-asset investors is an outdated stereotype.
But dealings on the secondary market remain opaque, and largely unregulated, throwing up an array of risks for those involved.
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Venture capital firms are managed by so-called general partners (GPs), who raise money from investors known as limited partners (LPs). These can include endowments, wealthy individuals or pension funds. The GPs invest the funds in nascent businesses, most often technology companies, in the hope of backing the next Uber or Airbnb.
The secondary market allows company founders, their employees and investors to cash out some of their equity without needing to wait for an eventual IPO or corporate buyout. For buyers, it is an opportunity to acquire a slice of a promising company that is not currently raising funds.
While there is no official literature documenting the first secondary transaction, it is widely accepted by secondary market participants that industry veteran Dayton Carr pioneered the trade by acquiring the LP interests of various venture funds from IBM in 1979, said a report by Industry Ventures.
Carr went on to found VCFA (Venture Capital Funds of America) Group, a New York-based firm that buys interests in private equity and venture capital funds, in 1982.
Venture capitalists wrote large cheques at record speed between 2020 and 2021, leading to sky-high valuations and unprecedented deal activity. The tide turned in 2022 as central banks raised interest rates to combat inflation, and the IPO market slammed shut. The amount raised in IPOs worldwide tumbled to US$146 billion in 2024 from a peak of US$641 billion in 2021, indicated data compiled by Bloomberg, and VCs have been forced to prolong their investment timescales beyond the 10 years that were once typical in the industry.
As a result, GPs have been resorting to the secondary market to generate the returns they need to keep their LPs on side. The secondary market is also a useful option for founders and their early employees to cash out or to grant new investors access to the company.
Often the business being sold has established a successful operating model and is focused on expanding its operations – known as a scale-up. Companies such as Stripe, SpaceX and Databricks have all facilitated secondary sales on behalf of employees who want to cash out their shares. A secondary sale can be more appealing than a sale of new stock, known as a primary fundraising, as it does not dilute the value of the existing share capital.
There is no single place, or even a single digital platform, for secondary sales. Big private companies often use banks to organise tender offers and deal with buyers on their behalf. Alternatively, online platforms such as Nasdaq Private Market can do the work of identifying interested participants.
Shareholders of private companies can also buy and sell stock to other investors. Platforms such as Forge Global and Zanbato allow users to buy and sell stakes in private companies, though participants need to be either accredited investors or ultra-high net worth individuals.
LPs can use the secondary market to sell stakes in the VC funds themselves. The buyers are typically other funds focused on acquiring assets through the secondary market, such as HarbourVest and Coller Capital, or other LPs.
GPs are also using the secondary market to offload stakes via so-called “continuation funds”. Here, an investment vehicle is created with money from a new investor and a VC fund’s assets are transferred to the new entity, with LPs given the option of cashing out. Because existing portfolios are being rolled into a new fund, these are seen as secondary market deals.
Most secondary transactions are straightforward sales of equity or fund interests at a discount to their most recent valuation. More specialist funds are doing “structured” deals in which, instead of a simple buy-sell agreement, custom deal terms are negotiated. Some of the more common structured transactions include deferral deals, meaning parts of the payment to the seller are delayed or contingent on the future performance of the asset, or forward contract deals, where buyers agree to buy shares at a future date on pre-agreed terms.
Despite the secondary market’s growing importance, it remains relatively opaque, with little regulatory oversight in comparison with public markets. The value of deals is small in comparison with trades on stock exchanges, which offer investors far more liquidity and price visibility.
With private companies subject to far fewer disclosure requirements than public ones, secondary buyers have limited access to data on a firm’s financial performance. They might not be fully aware of the company’s challenges or any fundraising plans that might affect its valuation. So agreeing on the price of a secondary market sale can be a fraught and drawn-out process.
Even when a buyer and seller settle on a price, the deal can be blocked by the company or stalled as another party might have a “right of first refusal” over the shares. Tom Callahan, chief executive officer of Nasdaq Private Market, estimated that one-third of direct trades are affected in this way.
Financial regulators in the UK have talked for years about establishing a platform attached to the London Stock Exchange for trading shares in private companies. The plan, known as Pisces, is yet to take shape.
US venture funds are largely exempt from regulatory oversight as long as they observe restrictions on their investments – devoting at least 80 per cent of fund assets to “qualifying” investments (equity securities that are purchased directly from private companies) and less than 20 per cent on “non-qualifying” assets, such as shares purchased on the secondary market.
Recently, more VC firms have been registering with the US Securities and Exchange Commission, exposing them to greater oversight and obliging them to make regulatory filings to the agency, so that they can breach the 20 per cent limit on assets acquired via secondary transactions.
The urge to do so has only grown since US President Donald Trump unleashed a tariff war, sending shock waves through financial markets and forcing private companies such as buy-now-pay-later firm Klarna and online ticket vendor StubHub to pause their IPO preparations.
“We’re expecting our secondaries team to become increasingly active, as the secondary market remains one of the few viable paths to liquidity,” said Mitchell Green, chief executive of Lead Edge Capital. BLOOMBERG
