Introduction
Secondaries are transactions where an existing stockholder sells their stock for cash to third parties or the company before the company undergoes an exit.
A secondary offering is not dilutive to existing shareholders as no new shares are created. The proceeds from the securities sold go to the seller, not the company. The offered shares are privately held by shareholders of the issuing company, which may be founders, directors or other existing investors such as venture capitalists.
Founders may decide to sell their shares to reduce their risk tied to the company or to get some liquidity to take care of necessary expenditures that may have arisen.
Who buys the founder’s shares?
- The Company: The company may repurchase the founder’s shares using company cash. Sometimes, due to the operation of the right of first refusal, the founder may be under an obligation to offer their shares to the company first before any third party.
- Investors in a priced equity round: The founder may also sell their stock to new or existing investors in a priced equity round.
- Third Parties: A founder may sell his or her shares to third parties. Specific platforms facilitate liquidity by matching interested investors with those who want to sell private company stock. For instance, the Nasdaq Private Market provides a secondary market trading venue for shareholders and investors of private company stock.
Possible Restrictions
- Right of First Refusal (ROFR): This right gives the company, in the first instance, and existing investors the choice to buy shares from a shareholder before the shares are offered to a third party. This means that even when a founder receives an offer for their shares from a third party, the founder is obligated to present the terms of the offer to the company and investors with the ROFR.
If they decide to purchase the shares within the set period, the founder must accept their offer over the third party. This restriction is not absolute; it may only lengthen the process of the founder selling their shares. Where the company and investors refuse to buy the shares, the founder is free to accept the offer from the third party. - Tag-along Rights: These are also referred to as Co-sale rights. These rights are typically put in place to protect minority shareholders in a company. Where a majority shareholder decides to sell their stake in the company, the majority shareholder is bound to include the minority shareholders in the negotiation. The minority shareholders can agree to sell or decline; if they choose to sell, their shares will be purchased at the same price and conditions as the majority shareholder. This may sometimes limit the number of shares a founder initially wanted to sell.
- Approval of the Board: Often, provisions in the Articles of Association or Shareholders Agreement may restrict a founder from selling their shares subject to the approval of the Board.
- Vesting of Founder’s Shares: Sometimes, founders do not receive all or any of their equity shares at the initial issuance. In this instance, the founder typically receives their ownership interest in exchange for continued work for the company. The award of stock will therefore vest over an extended period. This may restrict the period within which a founder can sell their shares. Founders can only sell their shares to get liquidity after they have become fully vested.