Who Needs an IPO? Why Startups Are Offloading Stocks on the

BY SAM BLUM, SENIOR WRITER @SAMMBLUM

Startups that might otherwise be mulling high-profile Initial Public Offering have been on the sidelines this year, as stubbornly high interest rates and geopolitical tension have given pause to founders and investors alike. 

That hasn't stopped a flurry of activity in the secondary markets, however, as reports from The Information and New York Times indicate that startups are still finding quieter ways to offload shares to both financial juggernauts and retail investors. 

Canva, purveyor of a photo-editing platform with more than $2 billion in venture funding, recently sold $1.5 billion worth of shares in a secondary sale. The largest investor in the transaction was Goldman Sachs, The Information reported. Figma, another startup in the digital design space, aims to follow suit in a similar deal that will also involve the investment bank, according to the report. Meanwhile, retail investors are pouring money into startups through third-party marketplaces, such as Destiny, in a private stock goldrush projected to reach $64 billion this year, the New York Times reports. 

While not as common as investing in public markets, secondary market investment is regulated under the same nearly century-old law--the Securities Exchange Act of 1934. 

The idea behind the ploy? Successful startups don't need the IPO market when it's not offering the kinds of returns that venture capitalists expect, Michael Ewens, a finance professor at Columbia University, explains to Inc. "When Reddit went public, I had conversations with people in the industry saying 'this will finally open the IPO window, right?' And it didn't." 

The secondary markets emerged as an attractive alternative to the sputtering IPO market at the beginning of the year. Limited partners, who provide money to venture capitalists, have seen diminishing returns, as many companies err on the side of caution regarding IPOs, the Financial Times reported in January. Selling stock to investment firms is seen as a viable way to return money back to LPs, even if they are recouping at a discount. 

"The main exit for VCs is primarily IPOs and [mergers and acquisitions], and neither of those are happening," Tom Callahan, chief executive of Nasdaq Private Market, told the FT. 

At mature, venture-backed companies, there is likely internal pressure from employees whose equity shares run the risk of expiring at the end of a certain ownership term. Selling shares to an investment bank can be a concession to employees as well as a retention strategy. "It's really difficult to get good engineering and software talent," Ewens says. "I would guess you want to retain these people, right? I think that's very likely what's happening." 

There is also an uptick in usage of platforms that allow everyday investors to make bets on the hottest startups. Those include Hiiv, Augment and ARK Invest, whose founder Cathie Wood shot to fame for evangelizing Tesla during its nascent days on the public market. These platforms have given some startups cause for concern, the Times reports, with some companies such as payments platform Stripe and the fintech startup Plaid indicating that they don't recognize this kind of secondary trading. Both Stripe and Plaid have said that Destiny doesn't own any of its shares, and Stripe has told its customers to report these secondary investment funds, according to the Times. 

By hawking access to shares in companies like SpaceX and AI developer Anthropic, secondary funds are throwing the kind of risk usually tolerated by venture capitalists onto retail investors who have less ability to absorb the potential downsides, says Alejandro Lopez-Lira, a finance professor at the University of Florida. There are "a lot of questions about whether we should just allow anyone to invest in startups... the main reason being that most startups fail, and it's extremely risky," he says. 

For example, ARK Invest was recently shamed as one the financial sector's 15 biggest "wealth destroyers," in a Morningstar analysis, which cited the firm's ETF, ARKK, as having lost $14.3 billion in shareholder value over the past 10 years. (Morningstar and Inc. parent company Mansueto Ventures have the same owner). 

There are regulatory limits to how much you can invest in these types of funds. In 2022, the SEC issued guidance on accredited vs. non-accredited investors: If you have an annual income of $150,000 you can only invest $7,500 in these types of schemes on an annual basis, according to the guidance. 

Companies that participate in either form of the secondary market might eventually spark the ire of their investors. "Generally, entrepreneurs want to stay private longer. That is, all else equal, bad for VCs who are trying to earn a return and liquidate their positions," Ewens says. "In the long run, it's not a sustainable thing for VC funds that are trying to generate returns."