The biggest problem with secondaries
This week, the news broke that the red-hot, incredulity-inspiring, addictive, cute-logoed “company” known as SnapChat had raised a gigantic round of funding. The story is far too massive to stay in the headlines for only one day, and so the next big point of chatter is their secondary.
Each founder just got paid $10 million.
For those who are unfamiliar with the concept of a secondary, this is when investors buy shares directly from founders — exchanging cold hard cash for illiquid shares. It’s not uncommon for VC funds to use this as a bargaining chip to win hot deals.
Given that rich, young, techies are the scorn of the world right now, it’s understandable why haters like ValleyWag love to report on secondaries. While at Bleacher Report, I participated in a large secondary -- and I lost a lot of money in so doing. That’s what happens when you sell equity for X dollars per share, and then the company subsequently gets acquired for “several X” per share.
So, this would probably lead one to believe that I feel pretty dumb about that. After all, I cost myself a boatload of cash. Well, actually, I don’t feel even slightly bad about it. And, in hindsight, I would have made the same decision. Which brings me to the biggest problem with secondaries…
There aren’t enough of them.
In my opinion, investors should encourage first-time founders to do them for large and late-stage rounds. There are a few reasons for this.
First, we have the issue of common sense. If you were to meet with your financial planner, and tell her that you have put 99 percent of your personal income into one stock, she would probably call you a fool. Then she would explain the concept of diversification. And she would make you watch that Downton Abbey episode where Lord Grantham loses his entire fortune on one railroad stock.
Venture capitalists have no right to encourage disgustingly irresponsible financial health any more than they have the right to encourage disgustingly irresponsible physical health. If your doctor told you that you needed to take a medication, or else risk severe physical consequences, I bet the investors would get behind that.
Believe me, if your net worth is 25 percent cash and 75 percent equity in your company... you will still work plenty hard.
The second reason to encourage a secondary is risk profile. Theoretically, when you already have money, you are more likely to "go the distance." That is, you won’t sell at your first offer. Okay, that last statement wasn’t fully true... because I said “theoretically” when I actually meant to say “absolutely.”
If you have a couple million dollars in the bank, you will absolutely take on more risk. Sure, the guys from SnapChat did more than a couple million, but this is all on a relative curve. They are shooting for stars like I have never seen before (and, frankly, wouldn’t totally advise). If they are going to give up on the chance of making $100-200 million each, then by all means take $10 million off the table.
Bleacher Report played "double or nothing" when we raised our Series D. We are fortunate that we achieved the former. But having some money in our bank accounts gave us the courage to do it.
Any founder who begrudges the concept of a secondary or pretends it will not impact incentive/risk choices is either (a) not being realistic, (b) too frightened to openly discuss the concept of a secondary, or (c) crazy.
But, then again, there are worse things than being crazy.
Finally, I should conclude this by pointing out that I would probably not be inclined to do another secondary, but it’s for all the right reasons. Once you’ve had a nice exit, the goal should be to one-up your last effort, by an order of magnitude.
That said, even though I probably won’t do it again, and even though I lost money the first time, the secondary was an important part of my first-time founder experience. It is something I am totally open about, that I fully encourage, and that every founder should feel free to explore with their investors and prospective investors.
And when the media gives you a hard time about it? Screw ‘em.