Unlocking liquidity for founders: the role of secondary share sales in venture-backed companies
Basil Moftah
Managing Partner at Key Capital
For founders of venture-backed companies, the journey from inception to growth can be both exhilarating and challenging. Many founders leave behind stable, lucrative corporate careers to pursue their vision, often investing significant amounts of time, energy, and personal capital without immediate financial rewards. As their companies grow and attract attention from growth-stage and pre-IPO investors, many founders face a critical question: how can they unlock some of the wealth tied up in their companies without relinquishing control or misaligning interests with early investors and new entrants?
Secondary share sales provide a solution for founders looking to de-risk their financial lives while remaining invested in their ventures. These transactions allow founders to release liquidity from their ordinary shares while attracting investors with deeper pockets, often via specialised secondary funds. This article explores how founders can structure secondary share sales using legal frameworks like special purpose vehicles (SPVs) and options, ensuring that their financial and strategic interests remain aligned with both old and new investors.
The founder's dilemma: releasing value without losing control
Founders who have taken their companies to significant growth milestones often find themselves asset rich but cash poor. Much of their personal wealth is locked in company equity, which, while valuable on paper, cannot be accessed easily without selling shares. Selling shares prematurely or in a poorly structured transaction could result in founders losing control of the company or creating friction with early-stage investors who may still be seeking growth. This is where secondary share sales come into play.
Secondary share sales differ from primary fundraising rounds in that no new shares are issued. Instead, existing shareholders, such as founders or early investors, sell their shares to new investors. This provides liquidity to shareholders while allowing new investors, typically growth or pre-IPO funds, to acquire equity without diluting the company’s ownership structure.
For founders, the challenge lies in structuring these transactions in a way that balances liquidity with long-term control and strategic alignment. Specialised secondary funds, which focus on purchasing existing shares, can offer founders creative financing solutions to achieve this balance.
Utilising SPVs for founder liquidity
One of the most effective ways for founders to structure a secondary share sale is through the creation of a special purpose vehicle (SPV). An SPV is a legal entity created specifically to hold assets — in this case, a founder’s ordinary shares in their company. By transferring their shares into the SPV, the founder can use the SPV as collateral to secure financing from a secondary fund.
Here’s how it works:
The founder creates an SPV, transferring their ordinary shares into the entity.
The secondary fund provides financing to the founder, using the SPV as collateral. This financing could be structured as a loan, which the founder can use to release liquidity or acquire preferred shares from early investors.
This structure allows the founder to unlock liquidity without having to directly sell their shares in the company. Instead, they retain ownership through the SPV, while also enjoying the financial benefits of the secondary transaction.
The SPV structure is advantageous for founders because it allows them to retain influence over the company’s future while gaining access to capital. It also gives founders the flexibility to negotiate favourable terms with the secondary fund, such as the right to repurchase the shares held by the SPV or refinance the loan at a later stage.
Corporate governance and consents: navigating internal approvals
Implementing an SPV structure within a company often requires careful consideration of corporate governance issues and obtaining the necessary consents from the company’s board, shareholders, and other stakeholders. These governance concerns typically arise because the founder’s sale of shares, even if structured through an SPV, can have a significant impact on the company’s ownership and decision-making dynamics.
The board and existing shareholders are likely to scrutinise several key issues:
Transfer of shares
Many companies’ articles of association or shareholders' agreements contain restrictions on the transfer of shares, such as rights of first refusal (ROFR) or drag-along/tag-along rights. Before the founder can transfer their shares to an SPV, they may need approval from the board or other shareholders. Founders must ensure that the transfer complies with these provisions to avoid disputes or legal challenges.
Voting and control
Transferring shares into an SPV might raise concerns about how voting rights are handled. Founders need to clarify whether the SPV will retain voting rights or if the founder will continue to exercise those rights on behalf of the SPV. Boards and other shareholders will want assurances that the transfer won’t disrupt the company’s existing governance structure.
Alignment with company strategy
The board and shareholders may also want to assess how the founder’s liquidity event aligns with the company’s long-term strategy. Secondary share sales should ideally occur without hampering the company’s ability to raise new capital or pursue growth opportunities. Founders should demonstrate that their partial exit won’t undermine their commitment to the company’s success.
Impact on shareholder value
Shareholders will be concerned about how the secondary transaction might impact the company’s valuation, particularly if the transaction is seen as setting a precedent for future sales. Ensuring transparency in the process and obtaining a fair market valuation for the shares can help alleviate these concerns.
To navigate these corporate governance and consent issues, founders should:
Engage early with stakeholders
Start conversations with the board and shareholders early in the process. Gaining their input and securing their buy-in from the outset can prevent delays or conflicts later on.
Draft clear agreements
Work with legal advisers to draft clear agreements that outline the terms of the SPV structure, including voting rights, governance provisions, and how the transaction aligns with the company’s broader goals.
Be transparent
Maintain open lines of communication with all relevant parties to ensure that the secondary share sale is perceived as a positive step for both the founder and the company. Transparent negotiations help build trust and foster alignment between founders, early investors, and new shareholders.
By addressing these concerns proactively, founders can create a governance framework that not only enables the SPV structure but also maintains the confidence of the company’s board and shareholders.
Secondary share sales allow founders to unlock liquidity from their equity while maintaining control and aligning interests with investors. These transactions offer a way to release wealth without issuing new shares or diluting the company’s ownership structure.
Maintaining alignment with early and new investors
One of the key concerns in any secondary transaction is ensuring that the interests of all stakeholders – founders, early investors, and new investors – remain aligned. Early investors who supported the company in its nascent stages may have different expectations than growth or pre-IPO investors, who are focused on scaling the company and preparing it for a liquidity event, such as an IPO or acquisition.
Secondary share sales can bridge this gap by allowing early investors to exit or partially exit, making way for new investors without disrupting the company’s ownership structure or governance. For founders, this means gaining liquidity while maintaining relationships with both sets of investors.
To ensure alignment, founders must carefully negotiate the terms of the secondary transaction, including voting rights, governance provisions, and future capital raises. By working with experienced legal and financial advisers, founders can craft agreements that preserve their strategic vision for the company while accommodating the goals of both early and new investors.
Conclusion: empowering founders through thoughtful secondary share sales
For founders of venture-backed companies, secondary share sales offer a powerful tool to unlock liquidity, reduce personal financial risk, and continue growing their businesses. By leveraging structures such as SPVs and incorporating options into their agreements, founders can ensure they retain control and flexibility while attracting the capital needed to scale their companies.
Specialised secondary funds play a crucial role in these transactions, providing financing and structuring solutions that empower founders to take advantage of favourable valuations without compromising their long-term vision. With careful planning and the right partners, founders can achieve financial freedom while maintaining their focus on driving their companies toward continued success.