What is a Secondary Sale? Risks and Challenges

A secondary sale is the process of selling shares by existing shareholders in a private business organization before the company’s IPO or acquisition. Investors and employees of a start-up can sell their shares to convert them into cash; in a company buyback, employees are typically limited to about 10% of vested shares. Unlike in a primary sale, the money goes to the seller, and no new shares are issued.

An IPO is when a company issues shares for the first time to the public, while a secondary offering is the sale of shares by current shareholders. It should be noted that in an IPO, the company offers newly issued equity stock, while in a secondary offering, the funds go directly to the existing selling shareholders.

Existing shareholders sell their shares through an underwriter who assists in setting the price for the shares and the public offering. This method is quite similar to an IPO, but it focuses on existing shares rather than new ones.

In VC, a secondary sale refers to the active selling of shares in a portfolio company by investors or employees to another investor. A secondary sale in VC is an exit strategy for stakeholders and employees to allow new investors to participate in business development. When many employees sell at once, the company may run a tender offer to outside investors; in a buyback, it typically caps each employee at about 10% of vested shares (a16z, 2021).

Points requiring attention in secondary sales include:

• Valuation: A lot of work goes into establishing an objective value for a share in a private company.
• Liquidity: Finding a buyer for shares in a private company is challenging.
• Regulation: These activities may also be subject to the parameters set by SaaS legal and regulatory provisions for subsequent sales. Most private companies also require board approval, and the company or existing investors often hold a right of first refusal (ROFR) to buy first at the same price (Ramp).
• Signaling: A founder’s sale of shares, particularly at a discount, can be interpreted by buyers as a relevant data point (a16z).