Secondary transactions, the sale of existing shares in a private company to a new buyer rather than the issuance of new shares to raise capital, have become a significant part of the private markets ecosystem. PitchBook estimated global secondary transaction volume at over $130 billion in 2023, a figure that includes both fund-to-fund LP secondaries and direct company secondaries. For operators, the relevant category is direct secondaries: transactions where an operator, early employee, or early investor sells existing shares to a third party, often a dedicated secondary fund, a new primary investor, or a strategic buyer. These transactions can provide meaningful liquidity without requiring a public offering or acquisition, and they have become more common as companies stay private longer.
How Mechanics Work in Practice
The mechanics of a founder secondary depend on the company's existing investor agreements. Most institutional investors include a right of first refusal in their investment documents, meaning that before a shareholder can sell to a third party, they must offer the shares to the company or to existing investors at the same price. The transfer restrictions in the stockholder agreement may also require board approval for any secondary transaction. This means the practical ability to execute a secondary sale depends heavily on whether the existing investors want to facilitate it. Investors who want to maintain price discipline around the most recent primary round valuation often resist secondary sales at lower prices, because a discount in the secondary market implies that the last round valuation was inflated.
A secondary sale at a discount to the last round price sends a market signal that the primary valuation was inflated. Existing investors have strong incentives to resist this outcome.
Tax Consequences
Tax consequences of secondary sales are a common source of surprises for early employees and founders who have never sold private company equity before. Qualified Small Business Stock, or QSBS, exclusions allow eligible shareholders to exclude up to $10M or 10 times their cost basis in gains from federal tax, provided the stock was held for more than five years and meets several other criteria. This exclusion can be worth millions of dollars in tax savings and should factor into the decision about when to sell. Shares sold in the secondary market before the five-year QSBS holding period is met lose the exclusion. The Section 83(b) election, which early employees and founders should file within 30 days of receiving restricted stock or early-exercise options, affects the tax treatment of any future sale including a secondary transaction.
Tender Offers
Tender offers are the organized version of secondary transactions, where the company or a lead investor facilitates a structured process for existing shareholders to sell a fixed amount of equity to a pre-identified buyer at a single price. Tender offers are common at late-stage companies that have raised significant primary capital and want to provide liquidity to early employees as a retention tool. The typical structure involves a 20-30 percent cap on the amount any individual can sell, a price set at or near the last primary round valuation, and a defined window of 20 to 30 days during which the offer is open. Companies running tender offers typically engage a secondary specialist like Forge Global, Nasdaq Private Market, or Carta to administer the process.
Strategic Considerations for Founders
The strategic question for founders is not just whether to participate in a secondary transaction but what signal participation sends to employees, new investors, and the board. A founder who sells a significant portion of their stake early signals reduced conviction in the company's trajectory. The convention is that founders should limit secondary sales to a level that addresses legitimate financial security needs without meaningfully reducing their economic stake. A founder who retains 80 percent of their pre-transaction holding after a secondary sale maintains alignment. One who sells 50 percent of their stake raises questions. Using tools like RECON to model the post-secondary cap table and equity waterfall scenarios helps founders and boards evaluate the financial and governance implications of a proposed transaction before committing to it.
Sources and further reading: PitchBook Secondary Market Annual Report 2023 | Forge Global Private Market Liquidity Report 2024 | IRS Section 1202 QSBS Guidelines | Carta State of Private Markets Secondary Transactions 2024
