The difference between a startup’s primary and secondary shares is straightforward: Primary shares are newly issued shares of stock, purchased directly from the startup company. Secondary shares are purchased from existing shareholders – investors, employees, or former employees – rather than the company itself. 

When the startup sells primary shares, those funds go back to the company. Venture capital financing is largely primary sales, and that’s how the startup raises capital. When secondary shares are sold, that money goes to the person selling the shares, not the company itself. It’s one way that existing shareholders, like founders or other employees, can access some liquidity and raise some cash for their personal expenses.

Who buys secondary shares? 

Usually, buyers of secondary shares are existing or new investors. If the company is doing well and has a lot of traction, new investors will want to buy shares. There may be VC funds that wanted to invest in a funding round, but the round is oversubscribed or the lead VC doesn’t want them to participate in the round. So they may buy some stock from existing shareholders to get in now, particularly if the company is successful.

Similarly, existing investors may want to add to their shares. Some existing investors, like VC funds, may want to increase their ownership share. So they may own 10 percent of the company in primary shares, but want to increase their ownership percentage to 15 or 20 percent. So they buy secondary shares. 

How does selling secondary shares work? 

There are differences in secondary sales, based on a number of factors. The shares aren’t registered on an exchanges, so the transfer has to follow state and federal laws. Startups often impose restrictions on secondary sales as part of the contract when issuing primary shares. Frequently, the company’s cooperation is a big consideration, since the company’s performance, financial condition, 409A valuation, and financial projections are important to pricing the secondary shares. The company’s bylaws, certificate of incorporation, and even insider trading policies can affect secondary sales. So secondary share sales are managed carefully, but secondary sales are an important part of the startup ecosystem. If you need more information about VC funding, startup equity, or startup accounting, please contact us.