If I had a penny for every time I’ve heard the notion that secondaries equal discounts, I’d be a rich rich man. The perception that secondary deals automatically come with a markdown has persisted for years (and it’s not entirely without reason).
Let’s zoom out to understand why this myth took hold in the first place – because that’s exactly how we’re going to bust it.
Two key points about the secondary market:
- A large part of the shares sold on the secondary markets are common stock rather than the preferred stock VCs receive when they invest.
Investors with preferred shares have strong legal rights that guarantee they get their money back before others. Common stockholders sit at the bottom of the capital stack with no special protections, meaning they only see returns after preferred stockholders are made whole. So in actuality, secondary buyers are not discounting the value of the company, just accounting for the gap in the value between common stock and preferred.
Think of it like a Taylor Swift concert – we all rush to buy tickets for the same show, but those sitting in the Golden Circle will obviously pay more than those in the far back stands. The price gap isn’t a discount, just the reality of a lesser concert experience 😉 - When the secondary market emerged 15 years ago, the market lacked tech-focused secondary funds that could properly assess tech startups’ value.As a result, buyers – not having an accurate estimate of the current value of a startup – indeed focused on the discount instead. Their inability to independently evaluate companies meant discounts became the default.
The reality today is different:
Secondary players, especially in developed tech ecosystems like Israel, have evolved.
We have the expertise to evaluate companies independently, just like any sophisticated VC would. We can buy from a company at any point in time, without relying on VC pricing, because we assess the value of the company comprehensively on our own.
When we price a deal, we look at:
- How much the company is worth now based on performance metrics (which may be significantly more than the last round if they’re performing well)
- What type of stock we’re buying (preferred or common)
- Are all existing stakeholders aligned around the company’s success
Remember, by definition, we need to be buying into objective winners. As passive investors, we’re not in the business of stepping in and fixing underperforming companies, we need businesses that are already executing well.
The price we pay reflects this reality, whether that lands above, below, or right at the last round’s number.
The Bottom Line: Sophisticated, tech-savvy secondary players have moved far away from the automatic discount approach of the past. Today’s secondary pricing reflects current market conditions and company performance, nothing more, nothing less.
Myth Busted 😎
