The secondary market, explained

Understand the function of the private secondary market and how companies can benefit from secondary liquidity and secondary market transactions.

What is a secondary market?

A secondary market is any financial market where investors buy and sell securities (like stocks, bonds, or options) from other investors, rather than directly from the issuing company. It’s “secondary” to a primary market, where securities are issued and placed into the market by an issuer in an IPO, priced fundraising round, or other initial offering. The two markets serve different purposes in a company's lifecycle, especially when it comes to raising capital and providing liquidity for shareholders. Understanding this difference is the first step to strategically managing your company's equity.

Primary market vs. secondary market

To fully grasp the secondary market, it’s helpful to understand its counterpart: the primary market.

The primary market is where securities are created and sold for the very first time. Both public and private companies can sell securities through a primary market. The most commonly known primary markets for public companies include the IPO market and the market for newly issued corporate bonds. Many types of investors participate in these markets, including institutional investors—such as mutual funds, investment banks, sovereign wealth funds, and hedge funds—and high-net-worth individuals.

When you raise capital through priced rounds from venture capitalists, you are also operating in the primary market. The company issues new shares, sells them to investors, and the proceeds go directly into the company's treasury to fund growth, hiring, and product development.

The secondary market, on the other hand, is where those shares are traded after their initial sale. No new shares are created in a secondary transaction. Instead, an existing shareholder, like an early employee or investor, sells their shares to another buyer. The flow of money is different, as the cash goes to the selling shareholder, not the company.

The public secondary market

The public secondary market is what most people picture when they hear "the stock market." It consists of organized and highly regulated stock exchanges, like the New York Stock Exchange (NYSE) or Nasdaq. On these exchanges, shares of public companies are bought and sold freely by the general public every business day, making it easier for investors to discover current market prices and decide whether to sell their holdings for cash at those prices.

This market is governed by strict rules from regulatory bodies to ensure fairness, transparency, and protection for all investors. For a startup, accessing the public market usually happens through an initial public offering (IPO), which is the complex and expensive process of becoming a publicly traded company.

The private secondary market

The private secondary market is where the buying and selling of private company shares occurs. This is the market that matters most to startup founders, their employees, and early investors before a company goes public or is acquired. It operates through specialized platforms and privately negotiated deals rather than on a public exchange.

Private secondary markets tend to be more opaque, less accessible, and less liquid than public markets. Historically, they have lacked the centralized infrastructure of exchanges like the NYSE, making it difficult for sellers to know if there is interest in buying and for buyers to know if there is interest in selling.

Trades occur less frequently, and the lack of a centralized marketplace and publicly required disclosures makes price discovery more difficult. While public secondary markets are accessible to most investors, the same isn’t true for private markets, which commonly are restricted to accredited investors who meet certain wealth or investment sophistication requirements to meet requirements under applicable securities laws.

What is a secondary market transaction?

A secondary market transaction is when shareholders of a company sell their stock to another investor. A venture secondary transaction involves the sale of private stock in a company backed by venture capitalists. Employees are frequently among the shareholders at venture-backed companies.

Companies can allow venture secondary transactions at any time, but they often do so in the weeks or months following a primary funding round.

Types of private secondary transactions

Tender offers

A tender offer is a formal, company-sponsored event where the company or a third-party investor makes an offer to purchase shares from a broad group of eligible shareholders at a predetermined price.

Direct secondary sales

A private secondary sale, also called a bilateral trade or direct secondary sale, is when one investor sells shares in a company directly to another investor in a deal that isn’t initiated or sponsored by the company.

Why run a secondary transaction?

While it might seem complex, a secondary transaction is an effective way to solve significant business problems. For a founder, understanding the strategic benefits is the first step toward using liquidity as a tool for growth, retention, and control.

• Provide employee and founder liquidity: A secondary transaction allows your early employees and co-founders to realize some of the value they’ve worked hard to create before a major company exit.

• Manage investor pressure and clean up the cap table: Offering a partial exit for early investors can relieve pressure on founders to sell prematurely.

• Gain a competitive edge in hiring: In a competitive talent market, the promise of future liquidity can be an effective retention and recruiting tool.

Frequently asked questions about secondary markets

Can a company block a secondary sale?

Yes, companies can often control or prevent direct secondary sales through transfer restrictions in their bylaws or by exercising their Right of First Refusal (ROFR).

How does a secondary sale affect our 409A valuation?

A secondary transaction provides a new data point on the value of your company's stock. Your valuation provider must consider this sale price when determining your fair market value (FMV) in your next 409A valuation.

What are the tax implications for employees who sell shares?

Employees who sell their shares will typically owe capital gains tax on the profit from the sale, though some may qualify for qualified small business stock (QSBS) benefits.