Primary vs. Secondary Offerings in Startup Funding

Introduction:

Startup companies often need to raise capital to grow their businesses and achieve their goals. In startup funding, the nature of transactions is generally of two types: primary and secondary. In this article, we will see the differences between these transaction types. We’ll also see who typically participates in these transactions and how they play a vital role in the lifecycle of a startup.

Primary Offerings:

• In primary transactions, the company issues new shares, and investors purchase these shares directly from the startup.
• The primary offering aims to secure capital for fueling the company’s growth and development.
• Primary offerings typically attract investors such as venture capital firms, angel investors, and family and friends etc.

Example:

For example, Startup ABC currently has 10,000 shares outstanding, with a total valuation of $10,000, where each share is valued at $1. Now, a new investor is ready to invest $1,000 in the startup. In response, the company opts to issue 1,000 new shares to the investor. Consequently, let’s examine the ownership stakes of both the promoters and investors after the funding. Also, let’s assume there are two founders in the company with each of them having equal ownership of the company.

Secondary Sale Offering:

• In secondary transactions, shares are acquired from existing shareholders, including investors, employees, or former employees, as opposed to being directly obtained from the company itself.
• Consequently, no new shares are issued, and the funds involved in secondary transactions goes to individuals/firms selling their shares. The money does not come into the company.
• As a result, this method provides existing shareholders, such as founders or employees, with a means to access liquidity and generate cash for personal expenses.
• Secondary transactions generally happen at a discount to Primary transactions.

Benefits of Secondary Offerings for outgoing founders and Investors:

Liquidity:

Secondary sales offer early VC investors and founders, quick liquidity and returns, bypassing the need for long exit events.

Diversification:

VCs can diversify their portfolio, reducing risk and freeing up capital.

Alignment and Incentives:

These sales align shareholders’ interests, letting early backers’ cash out while new investors bring value.

Benefits of Secondary Offerings for incoming investors:

Access to a growing asset class:

Startups are becoming increasingly valuable, but they can be difficult for investors to access directly. Secondary sale offerings provide a way for incoming investors to gain exposure to this asset class without having to go through the traditional venture capital route.

Discount in Secondary Sale Offerings:

Incoming investors can also benefit from discounts in secondary sale offerings. The amount of the discount in a secondary sale offering can vary depending on several factors, including the company’s stage of development, its financial performance, and the overall market conditions. Discounts of 15-20% are generally seen in secondary sale offerings.

Bottomline:

Primary and secondary offerings are essential tools for startup companies and investors alike. By understanding the key differences between these two types of offerings, startups and investors can make informed decisions about how to best raise and exit capital.

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