Term Sheet – Monday, July 21

Illiquid Till Exit: Is the golden era of secondary share sales over for startups?

Any startup that’s raised capital with a valuation in the hundreds of millions is on the radar of hedge funds, secondary market players and various other boiler rooms for private company stocks. (Call them “spawn of Advanced Equities.”) And it’s creating a thorny issue for startup CEOs. 

With startups waiting longer than ever to go public (and thus, leaving less hyper-growth on the table for public market investors), public market investors are under pressure to find high-growth opportunities in the private markets. When Dropbox raises $350 million, or Uber raises $1.2 billion, it’s basically like an IPO, except it’s not open to all retail investors. 

So these funds are getting aggressive in their quest for private company shares. One way they’re doing that is by blasting out solicitation emails to startup employees, offering to buy their shares at astronomical valuations. The offers might not be serious — it’s hard to know — but its enough for employees to get dollar signs in their eyes. It’s enough to prompt them to ask management about cashing out. 

This poses a problem: The company ’s board has a fiduciary duty to take any offers seriously, but at a ridiculous valuation, how can it? Further, if the company does say yes, it now has a random fund in its cap table, at a valuation much higher than the rest of the shares. There’s little precedent for deciding what class of shares the new buyer gets, and at a higher valuation, how many they get. “It’s a CFO’s nightmare,” one VC said. Not to mention, the insider trading laws for public companies apply to private companies as well, making compliance expensive and cumbersome as the shareholder base expands. 

Those issues are why, increasingly, companies are following the lead of startups like Dropbox and Uber and saying no to employee share sales. Based on an informal survey of investors, that’s been the trend since Facebook, which turned into the Wild Wild West of secondary shares before its IPO. At the time, SecondMarket and its peers were hailed as an innovative, entrepreneur and employee-friendly way to do business. It creates a real market with real values for private company stock, with less volatility, declared the New York Times. Secondary markets “act as a stent, relieving the congestion in the arteries of capital formation,” proponents told Businessweek in 2011. But the accounting nightmares it created left investors and CEOs who witnessed it turned off by the idea. 

The pendulum has since swung in the other direction, the investors Fortune surveyed said. (They requested anonymity to avoid the appearing unfriendly to entrepreneurs.) Venture firms now make strong recommendations to their portfolio company CEOs as early as a Series A fundraising that employee stock sales remain forbidden until a liquidation event. Companies have always had the right to refuse a potential share sale — they’re simply refusing a lot more now. If employees want to cash out, they have to wait for an honest-to-goodness exit.   

There’s one little issue with this shift: Saying no to employee requests for share sales becomes a poaching issue. Top executives at companies like Uber and Dropbox are among the most in-demand talent in Silicon Valley, and that’s not lost on Google, Facebook and Apple. The big public companies can offer an executive, say, a $5 million stock package with full liquidity. Uber can offer the promise of an IPO… someday. 

The move to more conservative secondary sale policies hasn’t stopped funds and advisory firms focused on buying shares from startup employees. (Take Battery East Group, a firm founded by former Blackrock exec Michael Sobel, and former Maveron advisor Barrett Cohn,  for example.) But the new twist on secondaries seems to be loans over share sales. Earlier this month, 137 Ventures raised $137 million to lend money to private company shareholders and employees who are rich on paper with illiquid shares. Another firm called VSL Partners, founded by GSV Capital partner Dave Crowder will offer the same thing.) 

So, if startups are becoming stricter about employee share sales, where will the funds hungry for private company shares invest their capital? Turns out, it’s all about who you know. CEOs are much more likely to approve a secondary sale if it’s to a firm they know and trust, and many of the firms springing up to facilitate sales start out with a relationship. Growth-hungry hedge funds and boiler rooms take note — befriend the next Drew Houston or Travis Kalanick, and you might have yourself a deal. 

THE BIG DEAL

• Nordic Capital has agreed to acquire a majority holding in Lindorff Group, an outsourced receivables management company based in Oslo, from Altor and Investor, for an enterprise value of EUR 2.3 billion ($3.1 billion). www.lindorff.com

VENTURE CAPITAL DEALS

• Threadflip, a San Francisco-based fashion resale marketplace, has raised $13 million in Series B funding led by Norwest Venture Partners with participation from earlier investors Baseline Ventures, First Round Capital and Shasta Ventures. www.threadflip.com/

• Yo, a messaging app based in San Francisco, has raised $1.5 million in funding from Betaworks and Pete Cashmore, among other investors. www.justyo.co/

• MedNet Solutions, a Minnetonka-based electronic data software company for life sciences, had raised $4 million from Arrowroot Capital.  www.mednetstudy.com/

• Unbabel, an online translation service based in Lisbon, Portugal, has raised $1.5 million from Matrix Partners, Digital Garage, WeFunder, FundersClub, Shilling Capital Partners and angel investors.  www.unbabel.com/

• Online Tours, an online travel service based in Russia, has raised $7 million in venture funding from Global Founders Capital, Holtzbrinck Ventures, InVenture Partners and E.Ventures. www.onlinetours.ru/

• Sensoria, a Redmond, Wash.-based maker of wearable sensors such as “smart socks,” has raised $5 million from Italian digital services company Reply SpA. www.sensoriafitness.com/

• DesignMedix, Inc., a biotech startup based in Portland, Ore., has raised $1.5 million in its second round of funding. Investors include Portland Seed Fund, members of Bellingham Angels, Oregon Angel Fund, Seraph Angel Network, Willamette Angel Conference, Keiretsu Angel Forum and Tacoma Angel Network. www.designmedix.com/

• ExactByte, a Raleigh, N.C.-based startup which operates government-related social media site ArchiveSocial, raised $1 million in funding from e.Republic Ventures. archivesocial.com/

• Workspot, a provider of mobile apps for workers based in Cupertino, a $6.5 million Series A round of funding led by Helion Ventures with participation from Translink Capital and Qualcomm Ventures. www.workspot.com/

• Health Warrior Inc., the Richmond, Va.-based maker of Chia Bar Super Snack health bars, has raised a $3.3 million Series B round of venture funding led by New Richmond Ventures, with participation from professional athletes including Arian Foster, EJManuel, Glover Quin and Mark Teixeira. healthwarrior.com/

• Epion Health, a health IT startup based in Lebanon N.J., has raised $4.5 million in venture funding from Deerfield Management. epionhealth.com/

• Privateer Holdings, a Seattle-based holding company focused on acquiring marijuana-related businesses, has raised $18 million towards a $75 million Series B round of funding. www.privateerholdings.com/

• Avere Systems, a Pittsburgh, Penn.-based enterprise storage and data management company, has raised $20 million in Series D funding led by Western Digital Capital, with participation from prior investors Lightspeed Venture Partners, Menlo Ventures, Norwest Venture Partners and Tenaya Capital. www.averesystems.com/

• TradeBlock, a data provider for cryptocurrency based in New York, raised $2.8 million in venture funding led by Andreessen Horowitz, alongside Barry Silbert, Devonshire Investors, and FinTech Collective. tradeblock.com/

• Crossfader, New York-based maker of an iOS app for electronic dance music fans created by the founder of Turntable.fm, has raised a strategic investment of undisclosed size from Tapinator, an OTC-traded developer of mobile games. Other Crossfader investors include Google Ventures, Kleiner-Perkins, Index Ventures, and True Ventures. crossfader.fm/

• Swoon Editions, an online furniture store based in the United Kingdom, has raised £4 million ($6.8 million) in Series A funding led by Octopus Investments with participation from Index Ventures. www.swooneditions.com/

• Ayannah, a Philippines-based digital payments startup raised $1 million from IMJ Investment Partners and Beenos, with participation from existing investors Siemer Ventures and Golden Gate Ventures. www.ayannah.com/

• GeneCentric Diagnostics Inc., a Durham, N.C.-based startup providing gene-based diagnostic technology has raised $5 million in Series A funding from an undisclosed investor. www.genecentric.com/

• ParkWhiz, a Chicago-based parking-spot finder, has raised $10 million in Series B funding led by Jump Capital, with participation from existing investors Hyde Park Angels, Hyde Park Venture Partners, Alexis Ohanian, Henry Feinberg and Amreesh Modi. www.parkwhiz.com/

PRIVATE EQUITY DEALS

• Energy Capital Partners has completed its $160 million investment in Furie Operating Alaska, an oil & gas company which plans to install an offshore natural gas production platform in Alaska, with capital from its Energy Capital Partners Mezzanine Opportunities Fund. www.furiealaska.com/  

• Summit Partners announced it has acquired a majority stake in Independent Vetcare Holdings Limited, a private veterinary group based in the United Kingdom, for an undisclosed amount. www.independentvetcare.co.uk/ 

• GTCR will acquire Cole-Parmer, a Vernon Hills, Ill.-based lab unit of Thermo Fisher Scientific, for $480 million. www.coleparmer.com/

• Great Hill Partners has acquired YogaWorks, a Los Angeles-based yoga studio operator with 29 locations, for an undisclosed price. www.yogaworks.com

• Vālant Medical Solutions, Inc., a Seattle-based provider of cloud-based, electronic health records and e-billing software, has received $10.7 Million in private equity investment from undisclosed investors. www.valant.com/

• Consulate Health Care, which operates the sixth largest provider of skilled nursing facilities in the mid-Atlantic region, has announced a deal to sell fourteen facilities to Formation Capital and Safanad Limited for approximately $150 million. www.consulatehealthcare.com/

• Nature’s Variety, a St. Louis-based maker of pet food backed by Catterton, has taken on an additional investment from Agrolimen, a Spanish consumer goods group. Through the deal, Catterton and Agrolimen will operate the company through an independent joint venture. www.naturesvariety.com/

IPOs

• Globant S.A. (NYSE: GLOB), a mobile, cloud and big data outsourcer based in Argentina, shares jumped by 30% on its first day of trading on Friday.  www.globant.com/

• TubeMogul (NASDAQ: TUBE) shares jumped by 64% to $11.50 on its first day of trading, after the Emeryville, Calif.-based online video advertising company slashed its debut price by 42%, the largest discount for a tech IPO this year. www.tubemogul.com/

• Trupanion, a pet insurance company backed by Maveron, Highland Capital Partners and RenaissanceRe Ventures, saw shares rise 14% on its first day of trading Friday. trupanion.com/
 

EXITS

• Samsung Electronics is planning to acquire SmartThings for around $200 million, according to a TechCrunch report. Based in Washington, D.C., SmartThings, a connected device startup for the home, has raised $15.5 million in funding from Greylock Partners, Highland Capital Partners, First Round Capital, SV Angel, Lerer Ventures, Yuri Milner’s Start Fund, A-Grade Investments, CrunchFund, Slow Ventures, Box Group and angel investors. www.smartthings.com/

• Retail Decisions, a United Kingdom-based payment fraud security service provider owned by Palamon Capital Partners, will sell to ACI Worldwide for $205 million. The sale will earn Palamon a 2.5x return on its 2006 investment, which included co-investors Morgan Stanley Alternative Investment Partners and AlpInvest. www.redworldwide.com/

• Isopure Co., a Hauppauge, N.Y.-based protein drinks company owned by Encore Consumer Capital, has hired Sawaya Segalas & Co. to sell itself, with a potential deal value of around $100 million, according to LBOWire. www.theisopurecompany.com/

• Mister Car Wash, Tuscon-based operator of Mister HotShine Car Wash and Lube Center chains which is owned by ONCAP, has hired Harris Williams & Co. to advise it on a potential sale, according to LBOWire. www.mistercarwash.com/ 

OTHER DEALS

• Oneflare, a home services marketplace based in Sidney, Australia, has acquired Renovate Forum, a community for renovators with 40,000 members, for an undisclosed amount. www.renovateforum.com/

• Bigpoint, a Hamburg-based online gaming company owned by Summit Partners, TA Associates, GMT Capital and Peacock Equity, has acquired Little Worlds Studio, Lyon, France-based mobile gaming company. www.little-worlds.com/

FIRMS & FUNDS

• 3i Group has raised €525 million ($710 million) for collateralized loan obligation, which aims to sidestep Volcker Rule requirements by not investing in bonds. www.3i.com/

• General Electric has priced the planned spin-off of Synchrony Financial, its North American retail financing business. The company will sell a 15% stake, or 125 million common shares, at $23 to $26 per share, valuing the company at $20.3 billion at the midpoint of its range. www.ge.com/ 

• Line, the Tokyo-based messaging app, announced a partnership with Collaborative Fund, a venture capital firm in New York, to invest in US start-ups. The fund has less than $10 million under management. Line, which made $508 million in revenue last year, announced its plans to go public last week. line.me/

MOVING IN, UP, ON & ON

• Adam Besvinick has been named Principal at Deep Fork Capital, where he will make early stage investments based in NYC. Prior to joining Deep Fork, Besvinick lead partnership efforts at Wanelo. www.deepforkcapital.com/ 

• Alexis Ohanian, co-founder of Reddit and angel investor, has joined Y Combinator as a partner. www.ycombinator.com/