The Secondary Deal Etiquette Keeping VCs From Cashing Out of Startups

In startup land, wanting a payout can look like betrayal.

As exits remain elusive, early startup backers and founders are increasingly turning to the secondary market to get some cash back on their long-held shares. But cashing out—even just a sliver—can trigger board backlash, founder resentment, or worse: a signal to the market that the rocket ship might be losing steam.

In this high-stakes environment, secondaries have become a necessary but delicate art form.

“For seed funds, secondaries are a must these days. Whoever’s not doing it is not keeping up to speed on the market,” said Itamar Novick, the founder of Recursive Ventures.

Novick wrote a pre-seed check into Deel in 2019. Over the years, as demand for shares of the $12 billion HR startup surged, he’s cashed out portions of that investment by selling to other existing Deel investors who wanted to boost their stakes and to new investors looking for additional equity beyond a primary fundraise. (Novick clarified that all of the deals happened before Deel’s legal battle with rival Rippling kicked off in March.)

Despite the rising demand for investor returns, however, it’s not open season for secondaries. Investors or founders hoping to get liquidity in a secondary sale have to carefully time, price, and brand the transaction, or risk sending catastrophic signals about the company’s outlook to the market at large.

“It’s a fairly bad signal for other investors to know the Series A lead wants to sell their shares at, say, a $5 billion valuation,” said Deedy Das, a principal at Menlo Ventures. “Why would later-stage growth investors want to buy in then? If the Series A lead doesn’t believe in the growth, why should we?”

That unspoken secondary market etiquette is at the center of VC’s liquidity dilemma, Das said. Investors hoping to sell part of their stake might piss off their founders, to whom any sale attempt can seem like a bet against the company’s future. Larger investors may not be able to sell any portion of their stakes without sending the markets reeling. And founders hoping for some liquidity through a secondary sale, facing the same market sentiment risks, might get blocked by their board of directors.

It’s blocking some investors from getting the returns they need in a stagnant exit market. Here’s how investors and founders are navigating those dynamics to cash out without disturbing the capital waters.

VC’s backup exit route

As VC exits through M&A and IPOs continue to stall, secondary deals are booming. The market for VC secondary investments into startups has surged to about $60 billion, up from $50 billion in the last quarter of 2024, per PitchBook. In the past year, investors have used secondary sales to scoop stakes in headline startups like OpenAI, SpaceX, Stripe, and Databricks.

The action is highly concentrated among VC’s biggest winners, however. On secondary market platform Hiive, the 20 startups facing the most demand accounted for 83% of secondary trading volume in the first quarter of the year.

At the top tier, founders often care less about existing shareholders looking for liquidity, since they’re swimming in investor demand, Das said.

The trouble comes when an investor wants to sell part of their stake in a startup with a more modest growth rate, perhaps that’s valued in the few billions of dollars — certainly an “upper class” valuation, but not quite part of venture’s 1% — after holding those shares for the better part of a decade.

“Then the founder might come back and tell you, ‘We’re going to the moon; we’re going to be a $100 billion company. Do you not believe in us?’ That’s a more frequent scenario,” Das said.

For founders, it’s personal, said Hinge Health CEO and cofounder Daniel Perez.

“We all have egos, and this is our baby. It’s our life’s work. Even when a seed or Series A investor wants to take a little bit off the top, you’re thinking to yourself, ‘this is going to be the worst transaction you’ve ever made, because the stock’s just going to keep going up.’ That’s what I initially thought,” he said.

But early-stage investors’ push for returns has become easy to empathize with. Dave McClure, the founder of VC firm 500 Startups who now focuses on secondary market buys with his latest firm Practical Venture Capital, said that small pre-seed and seed stage funds, family offices, and individual investors are especially squeezed when companies stay private for longer.

“That’s fine for maybe institutional investors, but it’s really a mismatch for everybody else that isn’t,” McClure said. “Maybe they were thinking they’d get their money back in seven to 10 years instead of 12 to 15 years. Now, they’re like, I’ve got to send my kids to college, I want to buy a house, I’ve got a medical emergency. At that point, of course they want to get some money back.”

Perez said that, as Hinge Health waited out venture capital’s exit drought, the physical therapy facilitated a tender offer in 2022 to allow early investors to get some returns on their stakes. The company had previously completed a $200 million secondary investment as part of its 2021 Series E fundraise, which brought some liquidity to Hinge Health’s employees and early investors, as well as to Perez and his cofounder. Perez said employees with incentive stock options that had vested their shares for at least one year were eligible to participate, which was true of most of Hinge Health’s employees at the time of the sale.

The company attempted another secondary sale for its investors in the intervening years before its IPO this May, but ultimately ditched the efforts after confronting a gap in pricing expectations between the intended secondary buyer and Hinge Health’s existing shareholders.

As the secondary markets mature, those transactions may not feel as emotionally charged. investors told BI. Still, shareholders should loop founders into their secondary sale attempts as early as possible, and ideally have a prospective buyer lined up to make the company’s job easier.

If the founders are completely against the sale, immediate liquidity may not be worth souring the relationship. Novick said that when he’s faced secondary deal backlash from founders in the past, he’s backed off his plans entirely.

Who gets to sell?

For most startups, only early investors can sell any significant part of their stakes without triggering a negative market reaction.

Investors who entered the company at its Series B or later, especially investors with board seats, are generally prepared to hold those stakes through an exit. Any failure to do that could spell trouble and hurt the company’s ability to raise money in the future, Slow Ventures principal Yoni Rechtman said.

“It’s a good argument for not taking board seats. That could signal something worse,” Rechtman said. He drew a connection to the public markets, where board directors selling shares can easily trigger a bigger stock selloff. “If this were a public company, how would it look?”

More risks arise when a founder wants to sell part of their stake. A founder secondary sale can trigger the rest of the company’s investors to try to sell shares, too, Novick said. Worse, it could hint to the market at large that the founder isn’t bought into the startup’s future growth.

“When the founder sells secondaries, hunting season starts,” Novick said. He noted that founders can’t get away with selling more than a very small portion of their stakes: “Any signal where the founder is selling more than 10% of their holdings is going to be disastrous, and it’s pretty likely to be blocked by the board.”

It’s not uncommon for founders to be approved to sell shares for discreet goals, like to buy a house in the ever-expensive Bay Area, Rechtman said. But larger deals are a different story entirely.

“When we see people selling between six figures and a couple of million dollars, it doesn’t bother me at all, assuming the company’s at a later stage, and especially if it’s part of a primary transaction. They’re basically clawing back the salary they deferred for the last several years working on the company,” he said. “When we see people doing really big blocks, such that they’re generationally wealthy no matter what happens, that’s really uncomfortable.”

Startup employees are often left out of the liquidity conversation entirely. While founders may work to organize employee tenders late in the company’s life to help get some cash back to their early joiners, employees generally aren’t allowed to try to sell their shares except in deals facilitated by the company, with little say in how or when that sale happens.

“The point of going to a startup is supposed to be that you work for a long time and eventually get rewarded in liquidity,” Hinge Health’s Perez said. “But now, employees aren’t getting any money back.”

Structuring secondaries

Early backers looking for returns should be careful of how much of their stake they sell at once.

Novick and Rechtman said early investors can generally sell 10% to 30% of their stakes without raising any eyebrows. Rechtman said he’d consider sales up to 50% standard for small funds, while Novick said an investor kicking off half of their position would be a large and more unusual sale. Any more than a 50% stake sale could raise red flags for the market.

Ideally, those sales happen as part of an equity fundraise that the company is already conducting. By pairing primary and secondary sales, the startup can send better signals to the market and handle changes to its cap table in one fell swoop. Investors told BI that the startup may charge a fee, which can fall either to the buying or selling shareholders, to cover the legal expenses and other work associated with executing a secondary sale “out of cycle.”

While most deals are enjoyed by tech’s hottest private startups, with far less demand down the food chain, Rechtman sees those deals, and the conversations around secondary market demand accompanying them, as “cultural priming” for transactions down the line.

“It was, for a long time, almost immoral or ugly to sell secondaries. It will take a long time for those cultural norms to change as the market norms do,” he said.