📄 Secondary Transactions

🎉 Happy Friday, funds family!

As private companies stay private longer, secondary transactions have become a fairly routine part of the venture landscape for mature private companies. It’s an important topic for the companies and the investors involved, because secondaries create liquidity ahead of an exit, but they also raise governance, valuation, and consent issues that differ meaningfully from a primary financing.

But what are secondary transactions?

The short answer is: a secondary transaction is the sale of existing shares by a current stockholder (e.g., a founder, employee, or early investor) to a new buyer, with the proceeds going to the seller rather than the company. Secondaries are typically subject to transfer restrictions such as rights of first refusal and co-sale rights, are priced by negotiation rather than by reference to the last round (although it is part of the decision usually), and raise distinct tax, information-asymmetry, and signaling considerations that everyone involved should understand before proceeding.

➡️ What is a secondary transaction and how does it differ from a primary round?

In a primary financing, the company issues new equity and receives the proceeds. In a secondary transaction, the shares already “exist” and the proceeds go to the selling stockholder, not to the company. The company’s cash position and total share count are unaffected by a pure secondary sale, though the buyer becomes a new stockholder on the 📄 cap table.

Secondaries typically take one of a few forms:

• Individual sales, where a founder or early employee sells a portion of their vested shares to a single buyer (for instance, a later-stage investor seeking exposure to the company).

• Structured company-run tender offers, where the company organizes a process allowing many employees to sell a limited amount of stock to one or more approved buyers simultaneously.

• Fund-led secondaries, where an existing investor sells all or part of its position, often to a dedicated secondary fund, sometimes to manage its own fund’s liquidity needs.

➡️ What consent and process rights govern a secondary sale?

A stockholder cannot simply sell shares to whomever and whenever they choose. Nearly every venture-backed company’s governing documents impose transfer restrictions, most commonly:

• 📄 Right of first refusal (ROFR): the company, and then often the investors, have the right to purchase the shares on the same terms before the sale to the outside buyer can proceed.

• 📄 Co-sale rights: also called tag-along rights; other stockholders (typically investors) may have the right to sell a proportional number of their own shares to the same buyer.

• Board or company consent: many charters and stockholder agreements require board approval before transfers (especially for common stock, as opposed to preferred stock), giving the company visibility into and some control over who joins the cap table.

A seller who ignores these mechanics risks having the transfer blocked or unwound, and a buyer who does not confirm that these consents have been satisfied risks a purchase that never actually closes.

➡️ How is the price typically set in a secondary transaction?

Secondary pricing is negotiated directly between buyer and seller and is not required per se to match the most recent priced round, though the last round often serves as a reference point. Pricing can diverge from the last primary round in either direction: a buyer may pay a premium for access to a hot company that is not otherwise raising capital, or a discount reflecting the illiquidity, information asymmetry, and the lack of governance rights that come with a primary investment. Because the buyer typically receives common stock (from a founder or employee seller) rather than preferred stock (though certainly not always, especially if the buyer is buying from a investor seller), the price is usually set below the most recent preferred round price, reflecting the difference in 📄 liquidation preference and other rights.

➡️ What should founders, employees, and investors watch for?

A few recurring issues come up in secondary transactions:

• Tax treatment: a founder or employee sale of vested shares is generally a capital gain (long- or short-term depending on holding period), but the analysis differs for options that must be exercised before the underlying shares can be sold.

• Information asymmetry: buyers in a secondary transaction often have less access to company information than a primary investor would, and sellers should understand what representations, if any, they are making about the company’s condition.

• Company visibility and control: companies increasingly prefer structured, company-sanctioned secondary programs over ad hoc individual sales, because uncontrolled secondaries can bring unwanted investors onto the cap table or create pricing signals the company did not intend.

• Signaling risk: a large secondary sale by a founder, especially one perceived as cashing out early, can be read by the market or by future investors as a lack of confidence, even where that is not the seller’s intent.

➡️ The practical takeaway

For the company:

1. Consider running structured, company-sanctioned secondary programs rather than leaving employees to negotiate individual sales; it preserves visibility and control over who joins the cap table.

2. Enforce and review ROFR, co-sale, and consent provisions consistently; inconsistent enforcement creates precedent problems for future transfers.

3. Be thoughtful about the signal a founder secondary sends to the market and to future investors, and communicate the rationale proactively if a sale is significant.

4. Keep the cap table updated promptly after any approved transfer so it accurately reflects who holds what (ask your lawyers to do so).

For the investor:

1. Confirm that all ROFR, co-sale, and consent requirements have actually been satisfied before closing a secondary purchase: an unwound transfer is a real risk. Reps and warranties are also important in this regard.

2. Recognize that a secondary buyer’s information rights are typically weaker than a primary investor’s; price and diligence accordingly, keeping that in mind.

3. Understand what you are actually buying: common stock from a founder or employee carries different rights than the preferred stock issued in the last primary round (from an investor, for instance).

4. For existing investors with co-sale rights, decide proactively whether to exercise them whenever a founder or major stockholder proposes a sale.

Thanks for reading, everyone!

Have a great weekend! 🙌

⚠️ Note: This newsletter is for informational purposes only and nothing should be considered legal advice. For that, hire a lawyer! I am a lawyer, but not your lawyer (unless I actually am your lawyer because you’ve signed an engagement letter and we’re working together). This may be considered attorney advertising.