This could be a typical startup flywheel story: Mikus Krams and Janis Vavere joined a promising Latvian startup Lokalise, a platform which helps companies translate and localise websites, apps and marketing materials, as early employees. After a couple of years, they sold their shares, and with the money started their own company: Trace.Space, a tool that manages requirements for complex engineering projects.

But there’s one element that makes this example different from the stories of former employees of Skype, Pipedrive or PayPal: Lokalise hasn’t had an IPO yet, nor has it been acquired — and it’s the exit moment when employees usually cash out their shares in startups. Instead, Lokalise allowed some of its employees to exercise their stock options and sell some of their shares to secondary investors during its $50m Series B fundraise in 2021.

Other big European scaleups have orchestrated secondaries sales — Estonia’s Wise sold secondary shares worth $319m in 2020, one year before its IPO; UK neobank Revolut also allowed current and former employees to sell shares in 2021.

But secondary sales could have an even more powerful effect while the IPO market remains sluggish and funding rounds are happening less frequently. They can also have an outsize impact in countries like Latvia, where there have been few exits to stimulate the ecosystem.

Krams and Vavere say that they got “around a year-worth” of their salary — and a real sense of what ownership in a startup really means.

“If you pay just a little bit to people, suddenly they realise it's not just some bullshit financial thing, there's actually money to be made,” says Krams.

“It just makes it easier for someone to leave a job to work on something on their own,” adds Vavere. “First of all, you see that it's real — the options canmaterialise into money. And the second thing is that you get a few months of [financial] cushion to actually work out [your new venture]. If it doesn't work out, then you can go back to work, but you don't have to think about it right away — you know you’re gonna pay your bills. It gives some optionality, it takes some stress away.”

Worth the wait

Stock options are supposed to incentivise the best tech professionals to join unpredictable, often stressful and not-so-well-paid startup jobs. They promise that when the company is much more successful — and worth much more — the employees will get a big payout to reward them for the value they helped create.

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But in Europe, it’s often not regarded as a real benefit. Regulations in European countries differ — with some governments placing a lot of taxation and bureaucratic burdens on companies that want to give out stock options, and the employees who take them.

Europe also hasn’t seen that many breathtaking exits that would make former employees really rich, and serve as an example for future founders. And given the tough exit environment in Europe, for many startup employees stock options remain a very abstract thing.

This is where secondary sales can give employees a taste of the reward waiting for them at the end of the tunnel.

In Latvia, which prides itself on being the country with the most stock-option friendly regulations in Europe, many startups offer an Employee Stock Option Plan, or ESOP, to all employees, from junior to seniors, from the day they join, subject to a vesting period.

Anastasija Oleinika, CEO of Printify, a Latvian print-on-demand marketplace, says that since there have been very few exit success stories in the country, startups often struggle to show the real worth of joining a ‘risky’ early-stage company rather than a ‘safe’ corporate.

“It's hard to sell to talent,” she says. Printify allowed some of its early employees to sell shares during its $50m Series A in 2021 — so, she says, the employees could get “a taste” of what stock options represent.

“In an environment where the IPO market is slower, and when mergers and acquisitions come under more scrutiny, we are seeing more common secondary [sales], which is the ability for early investors or employees to exercise and sell a portion of their stock,” says Isaiah Baril-Dore, who supports talent management at the porfolio companies of Index, the London-based VC that has been advocating for a better stock option environment in Europe.

“We've seen many secondary funds being active, approaching companies like us, looking for great deals,” adds Oleinika.

ESOP liquidity plan

Secondary investors typically buy shares from VCs and angels who invested early, founders — and employees.

Rando Rannus, general partner at Tallinn-based Siena Secondary Fund, says a secondary sale can be executed as a part of a funding round — “usually when you have larger international investors coming in and the round is oversubscribed,” he says. “Then they will put some cherry on top of the cake and make their offer more attractive… There can be some times that they're fighting to get their percentage in the cap table.”

He adds secondary sales can also take place in between funding rounds — this is how he invested Siena’s entire first fund.

Generally, secondary investors are only interested in buying shares in scaleups, he says. “We wouldn't come in if the company is in early traction. For us, for example, the threshold is around $10m annual revenue — when the main risk is taken away from the equation.”

He continues that companies that decide on ESOP liquidation need to have a valuation in the hundreds of millions. “I don't think the board will accept it if it's less than $100m.”

Employees usually can’t just decide to exercise their stock options and sell their shares. The sale has to be orchestrated by the company and often comes with a limit on how many of their shares employees can sell, and who they can sell them to.

“99% of companies have so-called transfer restrictions, which means that, for example, your neighbour can’t buy your options and transfer them to shares,” says Baril-Dore. “Because obviously the company and the board want to control who's on the cap table. [The sale] is controlled through either an IPO, a merger, or a secondary, and that is when there's a proven investor that can come in and sort of purchase shares more broadly across the company.”

The taste of what’s coming

Baril-Dore says he expects that there will be more cases of employees benefiting from secondary sales. “The US has a head start on this,” he says. “They've had equity legislation and a culture of equity for much longer. As we continue to see these changes in equity programmes and more ownership across [the ecosystem], I think we'll see more secondary markets, because people will be looking for that realised value if the IPO market is still slow to open.”

It can be one of the most “powerful” things to incentivise the best talent to join startups, he adds. “Because it transfers from paper money into something with which you can put a downpayment on a house to buy a car.”

Oleinika at Printify can’t agree more.

“That is a big thing for me as a CEO to think about how to allow employees to get a taste of what stock options really represent — even if it’s not at the end of the road, but somewhere in between,” she says. “Employees are more motivated to continue working because the investor invests in the team even more than in business.”

“It’s a personal aspiration of mine to show the market and show the community and to encourage both startups and employees to go down that path and to share the success — then you get teams that are really engaged and committed to the same goals as the investors and the founders.”