Venture capital drives our innovation economy. The system works because VCs fund risky ideas, founders build companies, and everyone shares in the success. At least, that's the story.
But what happens when this system breaks down?
Today's private market has transformed into something the original architects of venture capital might not recognize. Companies now stay private far longer, reach massive scale without public scrutiny, and operate under increasingly distorted incentives that hurt founders, employees, and investors.
The uncomfortable truth: the primary venture market prioritizes paper valuations over sustainable growth and fund economics over company fundamentals. This has created an environment where true price discovery is suppressed and complex terms hide beneath headline valuations.
When Incentives Break Down
The venture model was designed for a different era. Companies once went public at modest scale, creating natural alignment toward building sustainable businesses that could withstand market scrutiny.
Today's reality looks different. Private companies reach enormous scale before contemplating IPO. SpaceX generated $8.7 billion in revenue in 2023 – 280 times what Amazon produced before its 1997 public offering. This shift has created several problematic incentives:
1. The Management Fee Treadmill
Venture GPs earn wealth not just from investment returns but from management fees – typically 2% of assets annually. This creates incentives to raise larger funds, which requires showing paper "wins" to limited partners.
The result? GPs participate in follow-on rounds that inflate valuations regardless of economic reality. These paper gains help GPs raise the next fund, generating more fees, even if they never translate to actual returns.
2. Protection Over Price
When VCs lead later rounds, they negotiate liquidation preferences that protect their investment at the expense of common shareholders. These preferences include structures that create different classes of economic outcomes.
This means VCs can push for higher valuations with minimal risk – they get paid before common shareholders. The incentive to inflate valuation grows with each round, creating a precarious situation that only works if the next round comes at a higher price.
3. The Growth Obsession
The pressure to justify each round's higher valuation forces companies to prioritize growth over unit economics or operational efficiency. This distorts business development and often leads to premature scaling of unsound models.
Consider WeWork, which pursued hypergrowth to justify its sky-high valuation, only to see its business model collapse under public scrutiny. Or look at Convoy, once valued at $3.8 billion, which shut down after failing to balance growth with sustainable economics.
The current IPO drought, worse than during the 2008-09 financial crisis, reveals how many private companies cannot withstand the transparency of public markets.
Secondary Markets: Finding Truth
While primary rounds are choreographed events designed to manufacture consensus around an artificial price, secondary markets offer something valuable: actual price discovery.
When employees, early investors, or founders seek liquidity through secondary transactions, they confront the true market-clearing price of their assets.
We see this reality borne out repeatedly in transactions executed within EQUIAM's funds. We're currently closing two secondary transactions: a SpaceTech investment at a 25% price improvement to their January preferred round, and a productivity software deal at a 40% better entry point compared to their most recent funding round. Both deals reflect what we believe is the true intrinsic value of these businesses and the respective share classes we purchased.
Secondary transactions can reveal accurate pricing by stripping away artificial constraints:
- Buyers negotiate directly with motivated sellers, not companies seeking the highest valuation
- Buyers typically don't receive preferential terms and protections
- Buyers price current reality, not theoretical futures
The result is, in many cases, a price that reflects what the asset is worth to a rational investor – not what founders, existing investors, and bankers wish it were worth.
Why Primary Capital Still Matters
Primary venture capital serves an essential function. Early-stage companies need risk capital to develop products, find market fit, and scale operations. Demanding perfectly efficient pricing at seed or Series A would stifle innovation.
The issue isn't primary capital itself, it's the distortion that occurs as companies mature without increases in pricing discipline.
A robust secondary market doesn't diminish primary capital, it enhances it through feedback that makes primary markets more efficient. Just as public markets provide price signals that help companies price new stock offerings, secondary markets can serve this function for private companies:
- Secondary transactions establish fair market values that inform subsequent primary rounds, reducing contentious negotiations that delay funding
- With transparent pricing benchmarks, companies can raise appropriate capital at fair valuations, rather than pursuing inflated rounds that create unrealistic expectations
- Reliable liquidity options reduce pressure for artificial markups, allowing focus on sustainable growth rather than valuation engineering
- Most importantly, efficient pricing increases capital flow to deserving companies. When investors trust valuations reflect reality, they deploy capital more confidently
Companies that embrace secondary market liquidity create healthier businesses. They gain honest market feedback that enables efficient fundraising, reduces valuation disputes, and allows them to raise appropriate capital at fair prices before facing public markets or exploring acquisition.
Embracing Price Discovery
The venture industry has delivered remarkable innovations, and primary funding will always fuel technological progress. But we must recognize the flaws in today's private market and embrace the transparency that secondary markets provide.
The future belongs to those who build sustainable businesses that generate real economic value. The secondary market serves as the arbiter of reality where narrative meets numbers and hype confronts fundamentals.
The emperor may have no clothes, but a functioning secondary market ensures someone finally notices.
