How can founders and early employees get liquidity in financings?
Takeaway: A "secondary sale" allows founders and early employees to sell a portion of their vested stock during a financing round, providing early liquidity but requiring careful management to ensure founder incentives remain aligned for the long term.
The journey of a startup founder is a long and often illiquid one. While you may be "paper rich" as the value of your company grows, your personal wealth is tied up in illiquid private stock. The traditional venture model dictates that you must wait for a major exit—an IPO or acquisition years in the future—to achieve any personal liquidity. However, as financing rounds have grown larger and companies stay private for longer, a new trend has emerged: the founder secondary sale.
A secondary sale is a transaction where founders and sometimes early employees are given the opportunity to sell a portion of their vested stock as part of a larger primary financing round. It is a powerful tool for de-risking a founder's personal financial situation, but it must be managed with extreme care to maintain the long-term alignment of the team.
How a Secondary Sale Works
A secondary sale is almost always conducted as part of a major, late-stage growth financing (typically a Series C or later).
The Structure: A portion of the new investment from the venture fund is used not to buy new shares from the company (a "primary" issuance), but to buy existing shares directly from the founders and early employees.
The Rationale: By the time a company reaches its growth stage, the founders may have the vast majority of their net worth tied up in the company's stock. Allowing them to sell a small portion of their holdings (e.g., 5-10%) provides them with life-changing personal liquidity. This de-risks their personal situation and allows them to focus with renewed energy on building the company for the long-term, rather than pushing for a premature, sub-optimal exit.
The Investor's Perspective
Sophisticated late-stage investors are often supportive of a small, structured secondary sale for several reasons:
It Aligns for the Long Haul: They know that a founder who has achieved some personal liquidity is more likely to have the patience and ambition to swing for the fences and build a massive, independent company, rather than selling out early for a modest acquisition price.
It's a Retention Tool: It can be a powerful tool for retaining key early employees who have a large amount of vested, illiquid equity.
However, investors will be very sensitive to the size and structure of the secondary. A request from a founder to sell a large portion of their stock would be a major red flag, signaling a lack of conviction in the company's future.
Key Considerations
Board Approval is Essential: A secondary sale must be formally approved by the company's Board of Directors.
Right of First Refusal (ROFR): The secondary sale must still comply with the company's ROFR provisions, meaning the shares must first be offered to the company and its major investors before they can be sold to the new investor. This is typically waived as part of the overall financing deal.
A small, well-timed secondary sale can be a healthy and rational part of a startup's lifecycle. It can provide founders with the personal financial security needed to lead their company with confidence on the long journey toward a major exit.
Disclaimer: This post is for general informational purposes only and does not constitute legal, tax, or financial advice. Reading or relying on this content does not create an attorney–client relationship. Every startup’s situation is unique, and you should consult qualified legal or tax professionals before making decisions that may affect your business.