Understanding Secondary Market Transactions with Becki DeGraw | Wilson Sonsini Startup Legal Basics

TL;DR

Founder secondary sales have become more common, with early-stage companies now including them in funding rounds. Founders are typically allowed to sell up to 5% of their holdings, but this percentage decreases as the company becomes more mature.

Transcript

all right everybody welcome back to Startup legal Basics with my attorney Becky DeGraw from Wilson cincini welcome back to the program Becky Hi how are you good to be I am great it's great to have you back you and I do this every year or two we look at all the topics uh that Founders face Capital allocators face and we just try to have a really tho... Read More

Key Insights

• 🛝 Secondary sales have become more common in recent years, with early-stage companies now including them in funding rounds.
• 🥅 Founders' ability to sell shares is typically limited to maintain their motivation and alignment with the company's goals.
• 🪡 The prevalence of secondary sales increases with company maturity and the need for liquidity.
• 🖐️ Transfer restrictions and compliance with tax regulations play a crucial role in structuring secondary transactions.
• ❓ Companies and investors must carefully consider the impact of secondary sales on company value and the allocation of funds.
• 😇 Qualified Small Business Stock (QSBS) eligibility provides significant tax benefits for early investors and angels.
• 😒 The use of platforms like NASDAQ Private Market can streamline the process and ensure compliance with disclosure requirements.

Questions & Answers

Q: What was the prevailing view on secondary sales by VCs 20 years ago?

VCs believed that secondaries were detrimental to a startup's success, preferring hungry founders who were solely focused on an IPO.

Q: How have secondary sales evolved over the past few years?

In the past, secondaries were mainly reserved for later-stage companies, but they are now commonly included in funding rounds as early as series A. The prevalence of secondaries increased during the funding frenzy of 2020-2022.

Q: How much of their holdings are founders typically allowed to sell?

The general rule of thumb is that founders can sell up to 5% of their total holdings. However, as the company matures, this percentage decreases to maintain the founder's motivation and alignment with company goals.

Q: Are there limits on the amount of shares founders can sell?

While there are no specific dollar amount benchmarks, a common minimum for founder liquidity is around $1 million. The upper bound depends on various factors, but typically ranges from $3 million to $5 million to avoid potential distractions.

Summary & Key Takeaways

• Secondary sales were once rare but have become more common in the past few years, with early-stage companies including them in funding rounds.

• Founders are typically allowed to sell up to 5% of their holdings, although this percentage decreases as the company becomes more mature.

• The tension arises between allowing founders to sell some of their shares for liquidity while ensuring that they remain motivated to grow the company.