July 10, 2023
If you are a current or former employee of a highly valued startup or unicorn and you’ve decided you can’t wait any longer for an IPO to sell your shares, you’ve probably by now heard the term “secondary transaction” or “secondary sale.”
A VC secondary transaction is when a shareholder of a pre-IPO, venture capital-backed company sells their shares to someone else.
This is different from a primary transaction, where an investor purchases newly-issued shares from the company directly. When companies announce funding rounds, this is a primary fundraise. This is why private VC-backed companies are often referred to as the “issuer.” They sell, or “issue” new shares to investors to raise money to fund their business.
In a traditional VC secondary transaction, there are three stakeholders: the seller, the buyer, and the company.
Sellers in the VC secondary market include venture capital firms, angel investors, and current or former employees.
Amongst venture capital firms and angel investors, the most likely sellers are those who invested at a very early stage in the company’s life, such as at the pre-seed, seed or series A stage. These investors may have invested at a lower valuation, like $10 to $50 million, and the company is now worth $500 million, $1 billion or even more. These investors are sitting on a very large paper gain. As the average VC-backed company is staying private longer than in decades past, these investors may not be able to wait until the company goes public to generate a return. The VC secondary market is a potential opportunity for them to cash in some gains and show their investors a return.
By far, the largest group of sellers in the secondary market are founders, executives, and current and former employees of venture capital funded companies who are typically granted equity as a form of compensation.
Buyers in the secondary market can be investment firms or high-net-worth individuals (also known as accredited investors). There are several different types of institutions that are active in the secondary market, including VC funds, so-called secondary funds, hedge funds, family offices, and growth equity firms. Buyers in the VC secondary market can be current or new investors in the target company.
New entrants include wealth management firms and registered investment advisors who view direct investing into venture capital as a potentially attractive way to diversify clients’ portfolios into higher return alternatives to public equities and bonds.
The issuer needs to approve the transfer of shares from the seller to the buyer. The company could also become the buyer by exercising its right of first refusal (ROFR) to buy the shares at the proposed transfer price. In a future post, we’ll dive into more detail on the company approval process, the ROFR, and why some pre-IPO companies have a negative view towards VC secondary transactions.
If you’re a current or former employee or an existing investor of a pre-IPO company, we encourage you to sign-up for the Hiive platform here. Alternatively, feel free to contact [email protected] for more information.
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