Primary vs. Secondary Investment: Knowing the Difference in Private Equity
When choosing investments, an investor may come across a primary or secondary offering. The main difference between the two is that the primary market is where securities are created, while the secondary market is where employees, former employees, or individuals who own primary offerings, can attempt to trade their securities. Today, we’re breaking down primary vs. secondary investment types and examining the key differences.
What Is Primary Investment?
A primary investment in the private market is provided by an issuer, or a company seeking funding. Securities are created and sold in exchange for investment capital, commonly in the form of pre-seed, seed, or named funding rounds like Series A. The shares are transferred from company to investor upon closing of the round. Because the shares come directly from the company, they are considered primary investments.
Primary investments are commonly associated with early-stage companies that are seeking some of their first funding, but it is possible to have primary investments in later stage companies. Earlier named rounds, like Series A, B, and C, are traditionally considered early-stage investments. Because companies are not limited to a certain number of named funding rounds, issuers can sell securities across Series D, E, F, and onwards. These later-stage companies may still be raising capital through primary investment opportunities, but some of these later named funding rounds may only be open to institutional investors, like hedge funds or pension funds.
What Are Secondary Investments?
Secondary investments in the private market are provided by a shareholder instead of an issuer. Secondary shares can come from any existing shareholder in a company, but are most commonly sourced from investors like employees, former employees, or individuals that purchased in the Primary Market. For example, an investor may have made a primary investment in Company A. Perhaps a couple years later, they would like to sell that primary investment and exit their position in Company A. The investor could list Company A in the secondary market as a secondary offering. Once there is another investor willing to purchase the shares of Company A, the shares are transferred from investor to investor.
Secondary investments are most commonly associated with late-stage companies but are not limited to late-stage companies. Some early-stage companies may have investors seeking to exit their investment position and therefore could be traded in the secondary market. The timing of when an investor chooses to attempt to exit their investment position determines whether the secondary investment opportunity is in an early- or late-stage company.
Which Type Is Right for Me?
So which type of investment opportunity should a private equity investor be seeking when making decisions? That entirely depends on an investor’s personal situation, risk tolerance, and investing goals. Primary investment opportunities can be more risky than secondary investments, as they are more commonly associated with earlier stage companies that may not have the same user traction and achievements as a later stage company. However, secondary investments are not absolved of risk, and still have risks as all other types of investments, including total loss of capital. It also may not be possible to find a buyer for your primary shares in the secondary market.
Technically, a company’s shares could be listed on both the primary and secondary markets simultaneously, but the secondary investment opportunity most likely will be offered under different terms than a primary investment opportunity. For example, a company could be raising their Series C round in a primary investment opportunity. During this round, an investor in their previous Series B round may decide they want to attempt to exit their position in the company and lists their shares on the secondary market. These primary and secondary shares could be listed simultaneously, but different rounds of funding often have different terms regarding price per share, valuation/valuation cap, and conversion provisions. In addition, an investor may not be able to receive the same terms for their primary investment as when they made their original investment. Secondary shares are typically discounted from the original terms to make it more attractive for secondary purchasers.
It is important to take into consideration dilution and other factors when deciding between primary and secondary investments. To learn more about how subsequent funding rounds affect existing investments, check out our recent blog, Subsequent Funding Rounds.
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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.
