Secondaries in Brief

-- by Jessie Gabriel and Molly Traunbaugh

Last week I was at an investor lunch and found myself in an interesting conversation on the secondaries market. As I write that, I realize it sounds ridiculous (the word “interesting” might not be something you associate with conversations about secondaries). But we are who we are. These transactions were a big part of our practice in 2024, nearly matching the number of direct investment deals we handled for our fund clients. According to BlackRock, 2024 is on course to set a new record for the volume of secondary transactions with no indication of things slowing down in 2025. This is what happens when IPO and M&A activity is down–people need to find liquidity somewhere else. Even so, secondaries remain a bit of a mystery to most investors. In traditional All Places spirit, we’re here to break it down in plain English.  

*Note: this piece was written jointly by Molly and Jessie. Bonus points if you can guess who wrote which parts.* 

What is a secondary?  

A secondary transaction occurs when an investor buys stock from an existing shareholder of a company rather than directly from the company itself. Typically, the buyer is a new or existing investor, while the seller is an existing investor looking to exit its position or a founder seeking liquidity. Because the company is not issuing new shares in a secondary, these transactions allow outside investors to come in without diluting existing shareholders.  

What are the key terms of a secondary transaction?  

Share Price. The purchase price of the shares will be negotiated directly between the buyer and the seller, which is often based on factors such as the company’s current valuation, the terms of the shares the buyer is purchasing (e.g., liquidity preference or pro rata rights), how motivated the seller is for an early exit, and the performance of the business.  

Stockholder Rights and Obligations. The buyer will take on all rights and restrictions associated with the seller’s stock. This means buyers should carefully review the documents governing the shares to ensure a full understanding of the class and series of stock they are purchasing. For example, the liquidation preference of the stock may be calculated based on an original issue price that is lower than the purchase price of the stock in the secondary (more on this below).  

Consents and Waivers. The transaction may trigger certain approvals and waivers required from the company’s board and stockholders, such as rights of first refusal and transfer restrictions. Buyers and sellers must secure the necessary consents before the deal closes to ensure that the purchase is valid and authorized. It’s best to discuss this with the seller and the company early to avoid spending money on papering a transaction that is unlikely to close. The parties also need to confirm that the transaction complies with federal and state securities laws that restrict the resale of stock of private companies.  

Why do founders sell their shares? 

Founders are often the sellers in secondary transactions. This is because many founders’ assets are tied up in the company and they may need liquidity in their personal finances. Secondaries allow them to cash out some of their equity while waiting for their company to have an exit. This has been particularly true recently, as many companies are staying private longer than in past years.  

Secondaries with founders present unique issues for both buyer and seller. Founders should be mindful of the amount of equity they are selling and the potential control and voting rights they may give up in the sale. On the investor side, founder shares are almost always subject to company buy back rights before they can be sold to a third party, so the parties will need the company’s consent to the sale. Buyers should also understand the differences between the common stock usually held by founders and the preferred stock issued to investors—common stock will not have many of the rights granted to preferred stockholders, such as liquidation preferences, anti-dilution protections, information rights, conversion rights, pro rata rights, and other protective voting rights.  

Why do investors sell their shares? 

The other potential sellers in a secondary transaction are existing investors. These are people or firms who purchased their shares directly from the company in a previous round. As with founders, investors typically have to wait until the whole company experiences an exit via merger or IPO to get any cash in hand. Secondaries present an option for an earlier liquidity event. What motivates an investor to sell early? It is usually one of two reasons. The primary driver of many secondary sales is the achievement of certain fund metrics. If a fund is close to its target MOIC (multiple on invested capital) and can reach that target if it sells at the current offer price, even if it thinks the stock will continue to appreciate, it may sell now. The fund’s investors get liquidity and the fund can take that metric into the deck for its next fund. A distant second reason is that an investor has decided (for whatever reason) that it wants to close out its position in a certain asset class or industry. 

Why do investors purchase secondary shares?  

We now know why a founder or investor might want to sell their shares, but what motivates the purchaser in a secondary? Many people assume that if someone wants to sell their shares, the stock must not be very good. If it’s really going places, no one would want to get out, right? Wrong. In our experience, secondary sales are rarely motivated by a seller’s belief that the company is going south. Investors who have the liquidity and flexibility to purchase secondaries can often get access to companies they couldn’t access through direct purchases, or pick up shares at a discount if the seller is motivated. These purchases do, however, come with two distinct downsides. First, secondary stock is not eligible for Qualified Small Business Stock (QSBS) treatment. QSBS gives significant beneficial tax treatment to certain investments in small businesses, but it only applies to direct purchases of stock from the company. Second, if you are picking up preferred stock from a previous round, your liquidity preference may be limited. For example, let’s say you’re buying Seed shares that were purchased for $0.50/share, but you are purchasing them for $5.00/share. Your liquidity preference (the payout you get as a preferred investor if things go bust and there are limited assets to liquidate) is still determined by that original purchase price, regardless of how much you’re paying in the secondary transaction. 

Secondary investments give early investors and founders the chance to cash out their equity while offering new investors an opportunity to enter high-growth companies at later stages, and existing investors the chance to expand their equity position without further dilution. We expect these transactions to continue to rise in popularity as later exits continue to drive demand among shareholders for other liquidity options.