Sale of shares in secondary

Sale of shares in secondary

Secondary sales are increasingly important within startups. But let’s start by understanding what secondary sales are. These are essentially the transfer of already created shares from their current holders to new holders, who may or may not be shareholders of the company.

In other words, unlike one of the classic financing methods for a company, the capital increase, where new shares are issued and acquired by investors who either join as new shareholders or see their stake in the share capital increase.

In secondary sales, the company does not obtain any direct benefit; instead, the existing shareholders transfer their shares and receive the financial compensation.

Despite not bringing a direct economic benefit to the company, secondary sales are a very useful tool because they allow for cleaning up the cap table of minority investors and facilitating investment.

Regarding the cleaning up of the cap table, any founding team that has sought funding, especially from funds, knows that these investors usually view the existence of minority investors negatively. These minority investors were necessary in the early stages of the company but now dilute the share capital. Regardless of whether they are syndicated or not (although syndication in such cap tables is always recommended).

In response to this uncomfortable situation, secondary sales can be a good remedy. These minority investors almost certainly invested in the early stages of the company, meaning they did so when the company’s valuation was likely not very high.

As a result, if the startup has continued a growth phase in line with the company’s business plan, it is very likely that the purchase offer made by the investor will be beneficial to them. Even if it’s below the theoretical market price, remember that things are worth what someone is willing to pay for them, and they will obtain a multiplier in the transaction that meets their expectations.

Additionally, secondary sales facilitate the entry of new investors into the company. This is because it allows investors to enter the company at a lower price than the capital increase in which they will participate, and additionally, it allows them to participate in a funding round with less dilution, as the secondary purchase does not have dilutive consequences.

Although, as we can see, secondary acquisitions have many advantages, we should not forget that their execution must review the statutory limitations and shareholder agreements related to this transfer. We refer not only to the potential pre-emptive rights that existing shareholders or the company may have regarding the transferred shares but also to the fact that they might be subject to a lock-up period if they belong to the founding shareholders. Although, as mentioned, these sales are usually more common among the company’s initial investor shareholders.

In conclusion, secondary sales are a useful tool, especially for investor shareholders, but also for the company itself, as they allow for the regularization of the cap table and incentivize the potential entry of funds into the company.

At LetsLaw we offer specialized advice on startups.