Secondary Sales and Their Influence on Your Cap Table

Secondary Sales and Their Influence on Your Cap Table

As a growing business, you might be wondering what a secondary sale is and how it can impact your cap table. Secondary sales are transactions that occur between current shareholders of a company, transferring ownership of existing shares from one person to another. While traditionally, venture capital firms and angel investors have been the primary participants in the secondary market, recently, a growing number of individuals are also showing interest.

Secondary sales serve as a method for investors to liquidate their investment and exit a company. They also offer new investors the opportunity to acquire shares of a company without having to invest in a primary financing round. This method of buying and selling shares can have a significant impact on the structure of a company, especially regarding its cap table.

The Cap Table

A cap table is a spreadsheet that outlines the ownership structure of a company. It lists out all the securities issued by the company, who owns them, and how they were acquired. The cap table provides a comprehensive representation of the company’s equity, options, warrants, and convertible debt holders.

As a company grows, its cap table becomes increasingly complex. Primary financing rounds such as seed, Series A, B, and C, add more investors to the table, which results in more shares, dilution, and potentially more bureaucracy.

How Secondary Sales Partners Affect Your Cap Table

As noted earlier, secondary sales allow investors to liquidate their holdings. However, when an investor sells their shares, the company’s cap table changes.

A company can either create new shares to accommodate the sale or sell existing shares of the company held by other shareholders. Typically, investors sell their shares to other investors, and the company isn’t directly involved in the transaction. But, it still has a critical role in deciding whether the transfer of ownership is valid or not.

If a secondary sale of shares involves the transfer of significant ownership, then the company may need to approve the transfer. Most agreements between shareholders require Board or shareholder authorization to complete a secondary transaction.

By approving a secondary sale, the company is allowing a new investor to share in the future growth of the business, and the purchase price of the shares can directly or indirectly influence the valuation of the company. The cap table could also be affected by a transfer of shares, as the company needs to add the new shareholder and update the table accordingly.

Impact on Funding and Future Rounds

Internal transactions like secondary sales can influence the company’s funding and future funding rounds. If a secondary sale occurs at a lower price, this signals that the company’s growth rate may be stalling, making it more challenging to secure funding or attract new investors. Conversely, if a secondary sale happens at a higher price, it could increase the value of the company and make it easier to attract new investors.

However, a high valuation may also make the company vulnerable to a down round if it fails to meet investor expectations. A down round occurs when a company raises capital at a valuation lower than its previous financing round, which can have a negative impact on existing shareholders, including those who sold their shares in a secondary transaction.

Conclusion

Secondary sales can have a significant impact on a company’s cap table and future funding. While they provide investors with an opportunity to liquidate their shares, it’s essential to understand the implications of such transactions. Companies should carefully evaluate the impact of secondary sales on their cap table, future funding rounds, and overall business strategy. It is also crucial to ensure that transfers are made in compliance with the applicable regulations and the company’s internal agreement. By doing so, companies can benefit from secondary sales while ensuring stable and consistent growth.