The Psychology Behind Secondary Deals and How to Manage Risk

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One of the most meaningful things that accompanies entrepreneurs throughout their journey is their relationship with money - from the initial funding to the coveted exit. Money is the arena where many emotional dynamics play out, driving the entire ecosystem and ourselves as individuals.

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Back in 2001, Dror was very close to founding a secondary fund, but then 9/11 hit and upended things. Even then, he recognized the potential in secondary funds, but realized it wasn't the right timing yet. He waited another 7 years before the stars aligned to launch ISF (Israel Secondary Fund)  -

"I knew one thing: I'm not going back to being an employee. It was crystal clear to me from a very young age that I would be an entrepreneur." 

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When I asked where this steadfast calling came from, he shared the special upbringing from his parents, who gave him tremendous freedom to do almost anything he wanted. They pushed and encouraged him not to fear failure - no matter the outcome, he knew they would be there to support him. He grew up with the message: "Don't panic when it gets a little tough, tough is good." This perhaps explains his warm spot for extreme sports.

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How to Manage Fear?

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In both sports and entrepreneurship, Dror explains that fear is an important instinct - we need to be afraid.

"The big advantage is knowing how to control fear - I also enjoy certain situations where I'm afraid and then overcome them and look back." 

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He offers three main tips for dealing with difficult or scary decisions: 

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1. Decide at the right timing - make the final decision far enough before the 'scary event' when fear is present but not yet overriding -

"After we've decided, let's do it."

Don't let the mind decide when fear has already flooded the body right before, confusing us. Don't let peak moments of pressure grab the reins and dictate our choices; fear is here so we listen, not so it controls us.

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2. Draw a clear line - when taking a risk, understand your red lines that you won't cross; for Dror, mortgaging his home for an investment is unacceptable, as losing his home is not a risk he'll take. 

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For this we need to consider the implications of our decisions - what the day after looks like, how it impacts those around us. Only with a clear picture can we be at peace with the risks we take, a picture that includes far more than just financial risk, as Dror explains:

"In my MBA we learned money ranks around fourth or fifth in importance - the work challenge, ability to grow and work environment are much more important than how much money I make. For most of us money is not the main motivator."

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3. 18 months of security - Dror recommends ensuring you have breathing room of at least 18 months where you can scale back a little to explore a new passion or make a risky decision.

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Secondary Deals

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"Building a company in Israel takes 8-13 years, so there are many stakeholders who occasionally need liquidity - early investors who didn't expect such a long timeframe, founders who took major risks and want to see fruits of their labor, employees who also want to benefit from their efforts - this is exactly what we aim to provide." 

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Dror shares for many entrepreneurs, secondaries represent their first major money, so as a secondary fund they treat it with reverence -

‍"If VCs are the fuel propelling companies, secondaries are the oil reducing friction between stakeholders."

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We tend to think of secondaries as just for founders and employees, but they also serve investors - angels and funds can realize returns and recycle capital into new companies.

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It's important to discuss secondaries and the opportunities they present, both within co-founding teams and with investors, to align on an approach minimizing conflicts of interest. 

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To do this correctly, Dror mostly recommends secondaries between funding rounds, not around a specific round, as value builds without competing with investors. There's always some risk, but he notes the company's best interest comes first, so even if the risk doesn't pan out, the key goal of providing cash infusion is met:

"Don't confuse the company's capital needs with our personal needs."

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Dror explains this is where their role as a secondary fund comes in - knowing how to size deals based on the specific situation, including market timing and psychology of those involved and what they can handle. Alongside capital advice, he notes the importance of legal and tax diligence to get the full picture and evaluate each case individually.

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"The vibrant startup ecosystem in Israel is partly thanks to entrepreneurs doing secondaries, enabling them to also invest in other founders. Much of founders' motivation to sell today is to become angels themselves - they're building an ecosystem around them."

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It's important to have a healthy dialogue about money and recognize the value secondary mechanisms bring in strengthening the network of entrepreneurs and investors.

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"Secondaries exist in any market climate, but no doubt in challenging times like today with lower M&A, IPOs and investments in Israeli companies, become a critical tool."

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