What is a Secondary in Venture Investing
This is the fourth and final article in a series that discusses and demystifies some business concepts commonly encountered within a startups. When it comes to investing in startup businesses, we typically focus on the primary funding rounds, that is Series A, B, C, and beyond—where companies raise fresh capital to fuel their growth ambitions. But there's another important transaction type in the venture ecosystem that isn't discussed so frequently: The Secondary.
So What Exactly Is a Secondary?
In its most basic form, a secondary transaction in venture capital occurs when existing shares change hands without new capital going into the company's bank account. Instead of the company issuing new shares (referred to as a Primary), existing shareholders sell some or all of their shares directly to the new investors.
While primary funding can be thought about as growing the pie (bringing fresh capital into the company by increasing the total pool of shares), secondary transactions are about redistributing slices of the existing pie without diluting the existing pool of shares.
Who Sells Shares in Secondary Transactions?
Several types of stakeholders might participate in secondary sales:
Founders – After years of building with a reduced or even no salary, founders might sell a portion of their shares to reduce personal financial stress and reduce their overall financial risk by cashing in some of their investment whilst continuing to lead the company.
Early Employees – Subject to company or board approval, early team members who've been compensated partially in equity may seek some liquidity without waiting for an IPO or acquisition - supposing that those shares or exercised options are vested. But in reality employees and founders my be subject to lock up periods preventing them from freely selling their equity.
Early Investors – Angel investors or seed funds might sell shares to return capital to their own investors or to free up resources for new investments.
Departing Employees – People leaving the company might choose (or be required) to sell their vested shares.
Why Do Secondaries Happen?
Secondaries can serve several important functions in the venture ecosystem:
For Sellers:
- Diversification– After years of having net worth tied up in illiquid stock, secondaries allow investors to sell their shares and "take some chips off the table"
- Risk Reduction– It may be an opportune time for existing investors to convert some paper gains to actual cash, thereby reducing exposure to any future fluctuations in the value of the stock
For Buyers:
- Access to Sought-After Companies– When attractive startups aren't raising money as part of funding round, secondaries offer a way in for VC's that did not participate in a earlier round
- Increasing Ownership– Existing investors can increase their stake without waiting for the next funding round
- Strategic Positioning– New investors might use secondaries as a stepping stone to leading future rounds
For Companies:
- Team Retention– Allowing some liquidity can help keep valuable team members motivated for the long haul
- Cap Table Management– Companies can strategically bring in new investors or tidy up their cap table
In Summary
Recent years have seen an increase in the size and frequency of secondary transactions, with some notable secondaries taking place among high-profile fintechs like Revolut, Monzo, and Tide. Secondary transactions can offer a flexible mechanism for balancing the needs of various stakeholders in the startup ecosystem: providing liquidity for early believers, access for new investors, and stability for growing companies.
If you're building a venture-backed startup, understanding how secondaries work gives you more options for managing the financial future of your business gaining access to new working partners to help execute on your company's long-term vision. From an investors point of view, secondaries represent an additional avenue for accessing promising companies, even when they're not actively fundraising.
As the venture world continues to evolve, we may expect secondaries to become an even more common and strategic tool for startups navigating the long journey from founding to exit.