The market for secondaries amongst later-stage companies has seen a material uptick in recent years providing liquidity for early shareholders with IPOs being delayed and exit opportunities proving scarce. But secondaries are also making their way into the early stages of the ecosystem.
From $13 billion in 2012, the market for venture secondary deals grew to $60 billion in 2021, according to Carta. Of course, the funding environment looks different nowadays, but the secondary markets have proven rather stable.
In this current funding environment, as your business grows, secondary transactions can be an attractive option to help investors and founders achieve their financial goals while keeping the company on its growth trajectory.
For early investors, this offers an opportunity to sell a portion of their shares, especially the longest-held ones, while maintaining a significant share in the company, signalling ongoing belief in the company’s future success.
Especially for SEIS and EIS funds, whose fund investors are individuals and not institutions, secondaries enable them to provide some liquidity throughout the lifecycle of the investment. Under the current rules, shares which have been held for over three years can usually be sold while maintaining SEIS and EIS eligibility.
What is a Secondary Transaction?
A secondary transaction is a sale of shares from an existing shareholder, like a founder or an early investor of a private company, to another investor. In other words, investors are trading existing shares with the proceeds going to the seller, whereas in a primary transaction, an investor would purchase newly issued shares with the proceeds going to the company.
Key Benefits of a Secondary Transaction
1. Clean Cap Table
Over the lifetime of a company, the cap table often accumulates a range of different shareholders, including angels, smaller investors, and employees. While many of those provide vital support in the early stages of the company, as the business grows, their exit through a secondary sale can help streamline the cap table as well as the investor relations burden.
2. Increased Attractiveness to Later-Stage Investors
By simplifying the cap table and creating liquidity through secondaries for early investors the company can ensure its structure is clean and interests are aligned moving forward. Reducing the number of smaller, passive shareholders makes the company more attractive to key later-stage investors in future primary funding rounds, bringing on important funding and expertise for the later stages of the company.
3. Founder Liquidity
In today’s funding environment, IPOs take longer than anticipated, exit opportunities are harder to find, and funding rounds are taking longer to close. Secondaries can provide a unique opportunity for founders to take some money off the table without waiting for a full exit. This can provide some financial flexibility, allowing founders to continue focusing on the company’s growth and long-term vision. For some founders, a secondary sale of some of their shares can be life-changing, with secondary sale proceeds sometimes being sufficient to fund a house purchase, school fees or to pay down historic personal debts like student loans.
4. Timing Flexibility
Secondary transactions can be completely independent from primary funding rounds. This offers flexibility to arrange liquidity events without the pressure of managing a full capital raise or adjusting the company’s valuation. It’s a sale that can be arranged independently at a time most convenient for the company and existing shareholders.
How to Structure Secondary Rounds
When considering secondary transactions, it is important to keep a few points in mind:
- Identify potential buyers: Buyers for existing shares could be new investors, existing investors or institutional investors. Keep a tab on who might be interested and utilise brokers or secondary market platforms.
- And sellers: It usually makes sense to approach the 3-year+ shareholders on your cap table to gauge their interest in a secondary sale, whether of all (buyout) or some (partial) of their shares. At the outset you cannot necessarily guarantee there will be a buy or a market for the sale, but at least you can get a sense of appetite amongst your most loyal shareholders.
- Decide on timing: Secondary transactions can be organised independently of primary rounds, dependent on the appetite from sellers and buyers of existing shares. You can also make secondaries part of a primary round, reserving an amount for the transaction of existing shares.
- Beware of SEIS & EIS compliance: The investors in SEIS and EIS funds have received tax relief by investing in your company. There is a 3-year holding period for SEIS and EIS shares, which ensures the continued eligibility. Hence, selling those shares within this period is not an option.
At SFC Capital, we had partial exits through four secondaries in 2024. In two of these transactions, the founders of the companies also sold part of their shares.
Key Takeaways
Secondaries are becoming a common and powerful tool to provide some liquidity to early shareholders. Early investors are looking to sell some of their longest-held shares, which need to be older than three years for SEIS and EIS funds.
There is an array of benefits which include:
- Cleaning Up the Cap Table
- Increasing Attractiveness to Later-Stage Investors
- Providing Founder Liquidity
- Independence from Primary Funding Rounds
There is flexibility in timing, so decide on timing depending on the demand from both buyers and sellers of existing shares, either independent from or as a part of a primary funding round.
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