This Week On Practical Nerds - tl;dr

Founder secondaries can provide financial security for long-term commitment

Timing and context are crucial for secondary transactions

Secondaries may impact valuation and fundraising dynamics

Serial founders face different expectations for secondaries

Investor alignment on secondaries is key for smooth execution

Founder reinvestment can signal strong conviction in undervalued companies

The bull thesis would say, Hey, that's exactly what would allow a founder like that in that situation to re underwrite going for the big outcome.

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Founder secondaries can provide financial security for long-term commitment

We're diving into the world of founder secondaries today. It's a topic that can spark heated debates in venture capital circles. On one side, we've got the bulls who see secondaries as a way to keep founders motivated and committed for the long haul. On the other, we've got the bears who worry about misaligned incentives.

Let's start with the bull perspective. The argument here is all about potatoes. Yes, you heard that right - potatoes. Imagine two farmers. One is barely scraping by, living hand to mouth. The other has a barn full of potatoes. Which farmer do you think is more likely to take risks and innovate?

The bull says it's the farmer with the full barn. Why? Because they've got a safety net. They can afford to experiment with new farming methods or invest in more land. They're not constantly worried about where their next meal is coming from.

Now, let's translate this to the startup world. A founder who's been grinding for years without any personal financial gain might be tempted to take an early exit. But what if they could sell a small portion of their shares and put some "potatoes in the barn"? Suddenly, they might feel more comfortable swinging for the fences and going after that billion-dollar outcome.

It's not about making founders rich overnight. It's about giving them enough financial security to re-commit to the long-term vision. The bull argument says this actually aligns founders more closely with VCs who are looking for those massive, outlier returns.

Timing and context are crucial for secondary transactions

Now, before you go thinking secondaries are a free-for-all, let's pump the brakes a bit. Even the staunchest bulls agree that timing and context matter a ton.

Early-stage secondaries (think seed or Series A) are generally frowned upon. At that point, the company hasn't been de-risked enough to justify founders cashing out. The bull perspective is more focused on Series B and beyond.

We also need to consider the broader market context. Trying to push through a secondary in a down market or when the company is struggling? That's probably not going to fly. The bull case is strongest when there's high demand for the company's shares and things are going well.

Another crucial factor is separating secondary discussions from primary fundraising. If a founder is simultaneously trying to raise money at a high valuation while also selling their personal shares, it sends mixed signals. The bull would advise keeping these conversations completely separate.

The amount of the secondary matters too. We're not talking about life-changing money here. The goal is to put enough "potatoes in the barn" to alleviate immediate financial stress, not to fund early retirement. The exact number will vary based on personal circumstances, but it should be an amount that allows the founder to recommit to swinging for the fences.

Secondaries may impact valuation and fundraising dynamics

Let's switch gears and look at this from the bear perspective. One of the big concerns is how secondaries can mess with company valuation and fundraising dynamics.

Picture this: you're a founder trying to raise money in a tough market. You're already facing downward pressure on your valuation. Now throw in a request for a secondary, and things get even trickier. You're essentially saying, "Our company is super valuable and underpriced... but I'm also willing to sell my shares at whatever price you offer." See the contradiction?

This scenario can put a real damper on price discovery. It might lead to an even lower valuation than you would've gotten otherwise. And that doesn't just hurt the founder - it impacts all shareholders.

The bear argument says this is especially problematic in down markets or when a company is going through a rough patch. If founders are selling, it can remove any sort of valuation floor and things can spiral downward quickly.

There's also the question of optics. How does it look to potential investors if a significant chunk of a new funding round is going towards founder secondaries? It can raise red flags and make people wonder if the founders are truly committed to the long-term vision.

The bear perspective emphasizes the importance of founders having skin in the game. If too much value is taken off the table too early, it could reduce the motivation to go for those huge, venture-scale outcomes.

Serial founders face different expectations for secondaries

Now here's where things get really interesting. The venture capital world often has a double standard when it comes to secondaries. And it's a point that even the bears might have to concede.

Think about how VCs treat serial founders - those who've had successful exits before. We often see these founders get massive funding rounds for their new ventures, even though they might already have tens of millions in the bank from their previous exit.

The bull argument points out the logical disconnect here. We're totally fine backing a serial founder who's already financially set for life. We assume their previous success and current wealth won't dampen their ambition or drive. But when it comes to allowing a first-time founder to take a much smaller secondary, suddenly we're worried about misaligned incentives?

This is where the context of the founder's journey becomes super important. If you're dealing with founders who've been grinding away for 10, 15, or 20 years without any significant financial gain, the case for secondaries becomes a lot stronger.

For these long-time founders, a secondary might be exactly what they need to recommit to the next phase of growth. It's not about cashing out - it's about recharging and realigning for the next big push.

On the flip side, if a serial founder who's already had a big exit starts asking for secondaries in their new venture, that might raise some eyebrows. In that case, you'd want to dig deeper to understand their motivations and ensure they're still fully committed to swinging for the fences.

The key takeaway here is that context matters. The same secondary amount might be totally reasonable for one founder and a red flag for another. It all depends on their personal journey, financial situation, and future ambitions.

Investor alignment on secondaries is key for smooth execution

We've talked a lot about founders and VCs, but there's another crucial piece of the puzzle: investor alignment. This is where things can get messy if you're not careful.

Here's the deal: even if you've got a super pro-secondary lead investor (our bull), that might not be enough. In most cases, you need broader investor buy-in for a secondary to happen smoothly.

The problem is, the bear perspective we've outlined is probably more common in VC circles. So you might have one investor pushing for a founder secondary while others are strongly against it. This can create tension in the cap table and make execution a nightmare.

What's the solution? Well, if you're a founder considering secondaries as part of your long-term strategy, you need to think about this early. When you're choosing investors, try to get a sense of their philosophy on secondaries. Are they bulls or bears on this issue?

Ideally, you want to curate a cap table where investors are generally aligned on these issues. It doesn't mean everyone has to be 100% pro-secondary, but you want to avoid having drastically opposing viewpoints.

For investors, it's worth considering how your stance on secondaries might impact your deals. If you're staunchly anti-secondary, you might miss out on opportunities with great founders who are looking for more flexible capital partners.

The key is open communication. These conversations shouldn't be taboo. It's better to get everyone's perspectives on the table early, rather than having it become a point of conflict down the road.

Founder reinvestment can signal strong conviction in undervalued companies

We've covered a lot of ground on founder secondaries, but there's a flip side we need to talk about: founder reinvestment. This is when founders actually buy more shares in their own company, and it can send a powerful signal to the market.

Picture this scenario: a company is doing well, but the broader market conditions are tough. Maybe valuations across the board are depressed. The founders believe their company is seriously undervalued. What do they do?

In some cases, we're seeing founders actually invest their own money to buy more shares. This is like the ultimate show of confidence. It's the founders saying, "We believe in this so much, we're willing to put our own cash on the line."

This move can have a few positive effects:

1. It provides a valuation floor. It's hard to argue the company is worth less than what the founders are willing to pay.
2. It aligns incentives even further. The founders now have even more skin in the game.
3. It can inspire confidence in other investors. If the founders are buying, maybe we should too?
4. It can help bridge valuation gaps in tough fundraising environments.

Now, this strategy isn't for everyone. It requires founders to have personal capital to invest, which isn't always the case. But when it does happen, it's a pretty powerful move.

It's also worth noting the contrast here with secondaries. While selling shares might raise questions about commitment (fair or not), buying shares sends the opposite message. It's a clear signal that the founders see significant upside ahead.

For investors, seeing founders reinvest can be incredibly reassuring. It's one thing for a founder to tell you they believe in the company's potential. It's another thing entirely for them to back up that belief with their own money.

This doesn't mean every founder needs to be buying shares for a company to be valuable. But when you do see it happen, especially in challenging market conditions, it's definitely worth paying attention to.

The bigger picture here is about alignment. Whether it's through thoughtful secondaries that allow founders to recommit for the long haul, or through founder reinvestment that signals strong conviction, the goal is to create scenarios where everyone – founders, employees, and investors – is rowing in the same direction.

In the end, that alignment is what gives a company the best shot at achieving those venture-scale outcomes we're all after.

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