Buying secondaries in late-stage companies requires understanding liquidation preferences, participating preferred structures, and realistic exit scenarios. Our process for stress-testing private company valuations.
Secondary purchases in late-stage private companies—buying shares from existing employees, early investors, or venture funds—can offer compelling returns. You're entering after the company has proven its model, achieved scale, and validated its unit economics. You're not taking "will this work?" risk, you're taking "at what valuation will this exit?" risk.
But pricing these opportunities requires understanding not just what the company might be worth in an optimistic exit, but what you actually receive in various downside scenarios. The capital structure matters enormously—and most secondary buyers don't analyze it carefully enough.
Here's our process for mapping downside when evaluating late-stage secondary opportunities.
Before we can model exit scenarios, we need to know exactly what sits ahead of the shares we're buying. This means reconstructing the complete capitalization table: all preferred stock series, liquidation preferences, participation rights, conversion terms, and any other claims on exit proceeds.
Most late-stage companies have raised 5-10 rounds of financing, each with different terms. Early rounds might have 1x non-participating liquidation preferences (meaning they get their money back or convert to common, whichever is better). Later rounds often have 1x participating preferences (they get their money back plus they participate in the upside) or even higher multiples in difficult fundraising environments.
The company won't volunteer this information in detail. You'll need to request: the certificate of incorporation (which specifies all preferred stock terms), the most recent 409A valuation (which includes cap table detail), and ideally the most recent round's term sheet.
If you're buying common stock or early preferred series, you need to understand everything that sits ahead of you. If you're buying late-stage preferred, you need to understand what participates alongside you and what converts away.
Once we have the cap table, we model exit proceeds at various valuations: 50% of last round valuation, 75%, 100% (flat), 150%, and 200%. This shows how returns change as exit multiples vary.
For example, imagine a company valued at $2B in its last round, with $800M in total liquidation preferences (cumulative capital raised across all preferred rounds). You're considering buying late-stage preferred stock at a $2B valuation.
If the company exits at $1B (50% of last round), the first $800M goes to satisfy liquidation preferences, leaving only $200M for common and participating preferred. Your shares might be worth $0.30-0.40 per dollar invested—depending on exactly which series you bought and how participation works.
If it exits at $3B (150% of last round), you might return 1.8-2.2x—good but not spectacular given the risk.
This analysis reveals asymmetric risk profiles. In late-stage secondaries, your downside is often -50% to -70%, while your upside might be 2-3x. Compare that to earlier-stage venture where downside is -100% but upside can be 20-50x. Different risk/return profiles require different pricing.
The difference between participating and non-participating liquidation preferences dramatically affects downside outcomes.
Non-participating preferred (sometimes called "straight preferred") gives investors a choice: take your liquidation preference amount, or convert to common and participate in the remaining proceeds. You choose whichever is better. This is the standard structure in most healthy venture financings.
Participating preferred (sometimes with a cap) gives investors their liquidation preference amount PLUS participation in remaining proceeds alongside common stock. This is more investor-favorable and typically appears in down rounds, bridge financings, or when companies raised in difficult environments.
If you're buying common or early preferred in a company with later-stage participating preferred ahead of you, your downside returns can be severe. In our $2B company example, if the last $500M raised has participating rights, those investors get their $500M back plus they participate in whatever's left—leaving less for everyone else.
We've analyzed secondaries where common stock was worthless at any exit below $1.2B despite the company being valued at $800M—because participating preferences absorbed all proceeds at lower valuations.
To stress-test exit scenarios, we need realistic ranges for what valuation multiples are likely at exit. This requires looking at public company comparables and recent M&A transactions in the sector.
If the company is a SaaS business doing $200M in revenue, currently valued at $2B (10x revenue), we look at what public SaaS companies trade at: maybe 4-8x revenue for mature, profitable companies, or 2-4x for slower-growing or unprofitable ones.
This gives us exit scenarios: if the company grows revenue to $300M and exits at 6x revenue, that's a $1.8B exit—below its current $2B valuation. If it reaches $400M revenue and exits at 7x, that's $2.8B—a modest gain.
The key insight: late-stage private valuations are often set during peak growth periods and may already incorporate optimistic exit multiples. Unless the company significantly beats expectations or exit multiples expand, you may not have much upside from current pricing.
We weight our scenarios based on public market multiples and recent transaction comparables—not based on what would need to happen for the investment to generate a target IRR. Hope is not a valuation methodology.
Certain cap table features indicate trouble and dramatically affect downside protection:
Multiple rounds at the same or declining valuations (flat rounds or down rounds) suggest the company struggled to hit milestones and had to offer better terms to raise capital. These rounds often come with higher liquidation preference multiples, ratchet provisions, or participating rights.
Very high liquidation preferences relative to likely exit values—if the company has raised $800M and realistic exit scenarios are $1-1.5B, there's not much equity value left after preferences. You're essentially betting on a perfect outcome.
Multiple classes of preferred with different rights—when Series D has different participation terms than Series E, and Series F has a 2x liquidation preference while others have 1x, the math gets complicated quickly. Complex structures often hide unfavorable terms.
Large option pools or warrant overhangs—if 20% of the cap table is reserved for employee options or warrants to debt holders, your percentage ownership is diluted even before the next financing round.
Late-stage secondaries are illiquid investments with uncertain exit timing. Even if the company successfully IPOs or gets acquired, you may face lockup periods, earn-out provisions, or market conditions that delay liquidity.
We model time to exit in our return calculations: a 2x return over 5 years is a 15% IRR—decent but not exceptional for illiquid private risk. The same 2x over 3 years is 26% IRR—more compelling.
Many late-stage companies stay private longer than expected. They have access to growth capital at attractive valuations, management isn't eager to deal with public market scrutiny, or market conditions aren't favorable for IPOs. What was pitched as "18-24 months to exit" often becomes 3-4 years.
This time risk matters particularly when you're buying at premium valuations. If you pay 8x revenue for a company expecting it to grow into that multiple, but growth takes 4 years instead of 2, your IRR collapses—even if the ultimate exit is successful.
What could cause this company to exit below expectations? We brainstorm specific scenarios:
Revenue growth slowing faster than expected—most late-stage companies are valued on growth trajectory. If annual growth drops from 60% to 30% to 15% faster than projected, valuation multiples compress rapidly.
Competitive pressure—a larger player enters the market, an acquisition consolidates competitors, or a technological shift makes the current product less defensible.
Customer concentration—if 30-40% of revenue comes from a few large customers, losing one or two can crater the business.
Cash burn requiring a down round—if the company burns $100M annually and can't reach profitability before current cash runs out, it may need to raise capital at a lower valuation. This dilutes existing shareholders and can reset the liquidation preference stack.
Public market downturn—if the company is 1-2 years from IPO and public market multiples compress, the exit valuation resets lower.
These aren't hypothetical concerns—they're scenarios we've seen play out repeatedly in late-stage investments over the past several years.
Process note
We build detailed models for every late-stage secondary we consider, mapping exit proceeds to each share class at different exit values. This isn't something to estimate or approximate—the cap table math determines your actual returns, and small differences in liquidation preferences can swing outcomes by 50%+. Get the details right before committing capital.
Late-stage secondaries can be excellent investments when you're buying at reasonable valuations with clear downside protection. But they can also be traps—paying $2B valuations for companies that exit at $1.5B feels like a modest loss until you realize the liquidation preference stack meant your shares were nearly wiped out.
Map the downside explicitly. Model the cap table carefully. Stress-test exit assumptions against public market comparables. And only proceed when you have conviction that the downside is acceptable and the upside is real—not just what needs to happen to make your numbers work.