One of the biggest drawbacks of investing in startups is that it can be difficult for investors to exit their investments. Unlike shares of publicly traded companies that can be bought and sold on the same day, startup investments are typically illiquid, meaning that they cannot be easily bought or sold. Investors should expect to hold those assets for five to 10 years before an exit event happens (such as an acquisition or an initial public offering). 

But there is a way for investors to get liquidity for their startup investments. Secondary marketplaces are online platforms where investors can buy (and sell) shares in startups from existing shareholders (investors). This allows investors to exit their investments if they need immediate liquidity, skipping the years-long waiting period until the startup goes public or is acquired. 

The most popular “beta” secondary marketplaces for equity crowdfunding in the U.S. are StartEngine Secondary and Republic Secondary. StartEngine Secondary allows all types of investors to buy and sell shares in startups that have raised capital through StartEngine. Republic Secondary allows only accredited investors to buy secondary shares in startups that have raised capital through Republic CrowdSAFEs.

A Growing Market

There are some risks associated with using secondary marketplaces. First, the prices of shares on secondary marketplaces can be volatile. This is because the supply and demand for shares can change quickly based on speculation. Second, secondary marketplaces can also be illiquid if there is no demand for the listed shares. Third, some secondary marketplaces may not be properly regulated, so investors can encounter fraud on these platforms.

But despite these risks, secondary markets continue to grow. For late stage venture-backed startup secondaries — usually called “direct secondaries” — the global market size doubled between 2018 ($33 billion) and 2021 ($60 billion). This year, the market is expected to reach a whopping $85 billion. Many shareholders needed liquidity because of the recession, and many companies lowered their valuations to be able to raise more capital. As a result, more investors are interested in buying into those successful late stage startups.

Such late stage companies are attractive because they’ve already shown signs of great success. They have tens of millions of dollars in revenue, are backed by top tier venture capital (VC) firms, and because of the current recession, have dramatically reduced their workforces and burn rates to be more capital efficient. Also, non-VC investors cannot participate in these companies’ primary offerings, so a secondary marketplace is the only way for retail investors to invest in such companies. 

Platforms like Forge Global, NPM Capital, and EquityZen have facilitated billions of dollars’ worth of secondary transactions. As the market grows even more, newcomers like Stonks and CapLight are trying to compete with lower minimums and lower transaction fees for secondaries. 

There are also venture funds focusing exclusively on secondaries, such as 137 Ventures, MVP Ventures, and many others. Instead of competing with top tier VC firms to invest in hot startups, they buy shares in the same startups from founders, early employees, and early angel investors via tender offers, auctions, or direct sales. 

A Limited Selection

Founders and early employees typically sell their startup shares because they need cash to buy a home, pay off student debt, or handle other expenses. Early angel investors sell because they’ve already held the shares long enough to get considerable returns. Sometimes early VC firms have to sell because their fund term ends, so they need to liquidate all their positions and distribute returns to their limited partners. 

But the overwhelming majority of crowdfunded companies are seed stage and early stage startups with little or no revenues. These are not as attractive as late stage companies. Also, everyone has access to these investment opportunities, and these companies tend to raise almost every year. So investors can invest in the primary offering without needing to buy shares in a secondary market. Those primary offerings tend to stay open for three to six months — and sometimes for a whole year — at the same valuation. 

In addition, there are legal restrictions for shareholders to sell. For example, if you invest in a Regulation Crowdfunding round, you have to hold the shares for at least one year before you can sell it in a secondary transaction. Regulation A rounds don’t have those restrictions. But even so, who would buy those shares? And why?   

Don’t get me wrong, I’m all for creating and supporting secondary marketplaces for crowdfunded companies. But I think there’s a very limited selection for investors. I think the only attractive companies to buy in a secondary market are growth stage companies that show signs of early success and that are not raising on crowdfunding platforms every year, and super hot startups that got funded really fast. But in that case, who would sell? Unless an investor needs cash immediately, they would typically not want to sell their shares after only a year or so. 

It seems to me that the market size or transaction volume for seed and early stage secondaries of crowdfunded companies won’t be as big as people think. And when crowdfunded companies grow and show signs of early success, they usually go to VC firms for big money, VC support, and added value. In that case, such companies will be listed on the major traditional secondary platforms I mentioned earlier.

I hope I’m wrong.