Secondary Sale

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21 Aug, 2024

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Secondary Sale often refers to current investors selling their holdings to new ones, often to a third party, and so the proceeds stay out of the business. They happen when the business is performing well, and liquidation is not an option yet.

Existing investors who want a partial exit usually use the method to move on to newer investments. Secondary selling of shares reduces risk and helps reap the rewards from the business growth through the mitigation of potential liabilities. Especially when new capital is hard to come and primary funding increasingly becomes hard due to various reasons.

Secondary Sale Meaning

A secondary sale is a strategic method to attract new investment by selling shares to third parties. It helps capitalize on initial investment and benefits the selling stockholder.
The process involves determining the number of shares, considering shareholder rights, and complying with securities laws.
Factors like buyer accreditation status, shareholder tenure, and data accessibility are considered. Sellers must analyze transfer limits and collaborate with buyers to secure better pricing and deals.
Insider trading laws apply to transactions involving private company stock.

Secondary Sale Explained

A secondary sale is a strategic method to attract new investment through the sale of shares to third parties. The sale helps investors capitalize on the initial investment in the business. The selling stockholder benefits from the proceeds. This is not the same as a primary issue, where the business sells stock to a shareholder and keeps the funds for business needs. The sale may happen owing to issues in capital inflow, which could be a result of a valuation reset and unfavorable worldwide macroeconomic conditions.

The process involves determining the number of shares that can be sold, considering the impact of the sale on control over the company of the person making the sale. Factors subjected to change will include the rights granted to shareholders based on ownership and the ability to appoint or remove directors. The sales involve the transfer of stocks of a privately held company, which must comply with federal and state securities laws.

Important considerations include the buyer's accreditation status, the period the shareholder held onto the shares, and the accessibility of relevant data. Sellers must analyze any contractual limits on transfer imposed by private entities to see whether there are any particular challenges.

Collaboration between the company and buyers is crucial since buyers are willing to pay more when they are more informed about the company's track record, finances, and prospects. Even if selling stockholders have consented to keep sensitive information private, insider trading laws nevertheless apply to transactions involving private company stock.

Sellers need to think about these if they have important, exclusive information that the buyer does not. Buyers and sellers can obtain better pricing and deals in secondary sales by reducing the illiquidity discount. This can be done through firm cooperation, adherence to securities and transfer limitations, and readily disclosable information.

Examples

Let us look into a few examples to understand the concept better

Example #1

Here is a hypothetical example of an investor to understand the secondary sale of shares. David, an early-stage investor, purchased 5,000 shares of XYZ PharmaCo at $2.50 per share during its initial private funding round. The company's success in developing and commercializing innovative drugs led to a surge in its stock price. David decides to sell 2,000 shares to Emily in a secondary sale transaction at $50 per share.

He aims to capitalize on the increase in XYZ PharmaCo's stock price, secure financial stability, and fund other ventures. He also aims to diversify his portfolio by reducing exposure to the pharmaceutical industry. However, through the secondary sale of shares, David loses the opportunity to benefit from potential further appreciation in XYZ PharmaCo's stock price. He sacrifices some level of influence or voting rights in the company's decision-making processes.

Example #2

Eyewear retailer Lenskart has secured a $100 million investment from private equity major ChrysCapital. With this latest funding, the total investment in Lenskart amounts to approximately $600 million, of which around $450 million is attributed to secondary share sales. In a separate transaction, the Abu Dhabi Investment Authority (ADIA) invested $500 million in Lenskart in March, acquiring shares from existing investors, including SoftBank, Premji Invest, and Kedaara Capital.

While the specific exiting investors were not disclosed, it has been reported that SoftBank Vision, Kedaara Capital, TR Capital, and Alpha Wave Global (formerly Falcon Edge) have expressed interest in partially monetizing their investment in Lenskart.

Taxation

Capital gains are taxable, and it is the difference between the sale process of an asset and its valuation. Depending on how long they retain their assets, individuals may be subject to either short-term or long-term capital gains tax. Tax rate estimates on long-term capital gains are lower than those on regular income. The annual taxable income determines the amount of tax due. Short-term gains are typically subject to ordinary income tax, whereas long-term gains are subject to 0%, 15%, or 20% tax.

A short-term capital gain estimate occurs when an asset or investment is held for a year or less before being sold for a profit. IRS Form 8949 can be used to begin reporting sales that resulted in capital gains or losses. Use of Schedule D of Form 1040 can be done to determine hold time, basis, gain or loss, and net capital gain in order to compute capital gains taxes.

Secondary Sale vs Trade Sale

The differences between both the concepts are given as follows

Points	Secondary sale	Trade sale
Definition	Secondary share sale involves selling a part of the business to third parties.	A trade sale is an exit strategy where the existing management sells the business or a part of the business to an acquiring company.
Applicability	This happens only in a private company.	Trade sales can happen both in a private company and in a public company.
Return generation	They often achieve relatively low purchase prices, and they tend to generate lower returns	Trade sales, when compared to secondary share sales, generate more returns.
Type of exit	Sec sales tend to be an exit only for investors.	Trade sales tend to be full exits.

Frequently Asked Questions (FAQs)

1. What is primary sales and secondary sales?

Primary sales refer to an organization's first public offering of shares through an initial public offering (IPO) or direct issue, and the latter involves the sale of current shares in the secondary market by one shareholder to a third party.

2. How to increase secondary sales?

Individuals who are existing shareholders can concentrate on strengthening their relationships with investors by offering clear and accurate information. They can prove solid financial performance and put into practice efficient marketing plans to draw in new clients and boost secondary market trading in order to boost secondary sales of shares.

3. How to calculate secondary sales?

It does not typically involve a specific calculation. Investors, however, calculate it on a return basis and the market value.

4. What is a secondary sale in private equity?

Private equity secondary sale refers to the transfer of private equity interests from one investor or company to another. The process of private equity secondary sale involves the private exchange of ownership of shares in privately held businesses or investment funds.