What you need to know about secondary share sales in UK private companies

Secondaries are a theme of the moment in global venture tech: they provide pre-exit liquidity for investors on earlier (primary) funding rounds and allow those who missed the primaries to buy in.  They are a particular feature of developed venture capital markets where there are real prospects of significant exits.

Bay Area San Francisco, New York and certain other hot spots in the US are certainly markets of that kind.  The UK too, although with much of the volume and value concentrated in small handful of runaway fintechs, such as Revolut.

For those not familiar with the topic, here’s what you need to know:

1. What are secondaries?

The term secondary can mean various things, but – in the context of a private company going through the funding rounds on its way to a hopefully monumental exit – it means existing shareholders selling their shares and cashing out in whole or in part pre-exit.

Secondaries by definition will involve a sale of less than 50% of the share capital since otherwise there would be an M&A event and a full-scale exit of some kind.  They are typically sales of small or very small percentages of the cap table.

Secondaries sales will sometimes be offered by a lead investor to early shareholders as a way of ‘cleaning up’ (i.e., reducing the number of names on) the cap table as part of a new funding round.

Sometimes a company is so ‘hot’ that the only way that investors can get in on the deal is through a secondary: i.e. the allocation for the investment round was used up but some existing shareholders are willing to sell and cash out in whole or in part.

Or if a founder team is really lucky (and has a lot of leverage), the lead investor will offer to cash out some part of the founder team’s equity to de-risk their position a little and give them some liquidity in advance of the exit hopefully to come. 

2. So if that’s a ‘secondary’, what’s a ‘primary’?

Typically, those shareholders selling in the secondary were issued with their shares in a prior funding round.  Confusingly, those funding rounds aren’t usually called ‘primaries’, although sometimes secondary share sales take place at the same time as a – primary – funding round and so primary and secondary as terms can be used there to distinguish between the funds being raised by the company in return for issuing more shares and existing shares being sold by existing shareholders. 

3. Got it. So, the company doesn’t get the money on a secondary?

Yes, that’s right.  Secondaries do not raise new capital for the company.

It is though possible to structure a deal where some or all of the proceeds of the secondary are re-invested into the company, but that is unusual and sellers typically want to keep the cash they have raised (and may be paying capital gains tax on).  There are, however, some narrow circumstances involving bridge rounds and departing/ed founders where a re-investment of the proceeds might be made to work commercially.  

4. So is the company involved at all?

It is involved. As a minimum, the board of directors will be asked to register the transfer of shares and, in doing so, perfect the transfer of legal title.

But questions as to who benefits from the secondary need to be borne in mind by the company directors when they are asked to register the transfer and if they are brought into negotiations generally.   A director must – amongst other considerations – act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its shareholders as a whole.

Directors must also avoid conflicts of interest.  If a director is a seller or is a buyer, then close attention must be given to the conflicts regime set out in the company’s articles of association and under the Companies Act 2006.

The actions of the company and the involvement of its directors on historic secondaries may well be looked at going forward in due diligence processes.  So too the price. 

5. Who sets the price?

Buyers and sellers are free to set whatever price they like.  That said, typically the price is set at the latest post money value or at some discount to it. 

6. What about tax?

Wherever the buyer and seller may be resident, UK stamp duty will apply on UK secondary sales.

Stamp duty is charged on an ad valorem (‘according to value’) basis at 0.5% of the chargeable consideration (and in limited circumstances by reference to market value), rounded up to the nearest £5.  Stamp duty must be paid within 30 days of execution; interest and fines apply to late submissions.  Transfers are exempt where the aggregate consideration is £1,000 or less (and there is a section on the back of the stock transfer form to complete). There are, unsurprisingly, stringent anti-avoidance provisions to consider.

Typically, the buyer pays the stamp duty.  If the secondary is taking place as part of a wider set of transactions, the company may agree to pay the stamp duty instead.

Sellers resident in the UK will want to take advice as to their capital gains tax exposure.  This is particularly important if the sale is at less than market value.

Buyers and sellers who are or who might be employees of the issuing company (or who hold the shares by reason of a connection to an employee) ought prudently to take advice as to whether liability to income tax is incurred under the UK’s employment related securities regime, particularly if the buyer is an employee or connected to one and a discount on the pricing has been agreed.  So too will the company since – if so – there could be employer’s national insurance contributions to pay and tax to be paid through payroll. 

7. What sale documents are involved?

The instrument of transfer is a stock transfer form, although in extremis other forms of documents can work and be put forward to be stamped by HM Revenue & Customs.  Stamp duty is a tax on documents after all.

The contract by which the sale is agreed to be made is the sale and purchase agreement (SPA).  Typically, that agreement is made under English law – and we would invariably recommend that it is since the asset in question will be shares in a UK company – but it does not have to be.  You don’t have to have an SPA at all, but buyers typically want one for some of the reasons covered below.

With the SPA duly executed, and the stock transfer form signed and dated, the buyer has beneficial title to the sale shares.  The prudent buyer will have sought and obtained a power of attorney in the SPA to cover the period in between obtaining beneficial title and legal title on registration of the transfer.

The company’s articles of association then dictate what happens next, and what restrictions apply on transfer.  They should have been checked in advance and any necessary consents or waivers obtained to avoid any nasty surprises.

To perfect and obtain legal title, the buyer must present the stock transfer form to the company’s board of directors for registration.  The transfer can only be registered if the stock transfer forms have been stamped or the transfer is exempt from stamp duty – it’s a criminal offence to do otherwise.

If the buyer isn’t already a party to the shareholders’ agreement, they’ll likely need to execute a deed of adherence (at the same time as executing the SPA) so as to become one.  Buyers ought prudently to have read and considered what that shareholders’ agreement says and what obligations they will take on by executing the deed of adherence.

8. Nasty surprises?!?

Typically, companies going through the funding rounds will have pre-emption rights on transfer in their articles.  These say that shares offered up for sale need to be first offered to the existing shareholders (or certain classes of them).

If those haven’t been dis-applied in advance, or if the sale does not fit into an existing class of permitted share transfer not subject to restriction, then there is a problem, potentially a major one.  The SPA is a private agreement between the buyer and the seller.  Typically, the company isn’t a party.  The other shareholders won’t be parties.

So too and on the same basis must the investor consent regime (in the articles but also, typically, in the shareholders’ agreement) be checked to see whether or not the consent of the lead investor or some group of investors is needed in order for the transfer to go through.

There are frequently other types of restrictions to consider: co-sale rights for instance typically say that employee shareholders selling out have to make the same deal available to everyone else at the same price before they can do so.

This is all in marked contrast to sales of shares in UK public companies, which are generally freely transferable outside of lock up periods. 

9. What about price adjustment?

Secondaries are, invariably, fixed price deals and do not usually involve the kind of completion accounts or locked box price adjustment mechanism that one sees in an M&A context on a sale of the entire company.

There is invariably no tax covenant either, and so no chopping up of pre- and post-completion tax liabilities within the company between buyer and seller.

One could of course write these kinds of things into the SPA, and the buyer and seller can to large extent agree whatever they like between them, but the costs of doing so are usually prohibitive and the buyer is not typically in a position to demand that the seller signs up to them.

With sellers invariably giving title (to the sale shares) and capacity (to sell them) warranties only (and not a full suite of business warranties or any indemnities), there is usually next to no scope to renegotiate price after the event.

What can be easier to draft in is a deferred payment schedule, with the purchase price to be paid up in tranches going forward.

10. So it’s buyer beware?

Yes, very much so.  Fraud, however, cuts through all and if proven would be a way to unwind the transaction after the event.

If the buyer did insist on a full suite of warranties, the seller is then going to have to disclose (and if they are not in the executive management team there will not be much that they can disclose) which takes time and further cost.  If the buyer on the secondary is also an investor on a primary taking place at the same time, they’ll likely get that full suite of warranties in the subscription agreement and against which disclosures will be made in a disclosure letter. 

11. Can the buyer get a liquidation preference on the shares it acquires?

The shares acquired will come with whatever rights and obligations are set out in the articles as applying to that class of shares.  If they are ordinary shares acquired from management then they won’t typically come with a liquidation preference.

Post acquisition, shares can be converted from one class to another with a resolution of the shareholders and – typically – investor consent obtained.  In those circumstances, look out for how the drafting of the preference actually works because it may refer back to the original issue price of the shares.  Management’s ordinary shares will or may have been acquired at nominal value and not at the price at which the investor paid for them in the secondary.  Where so and if the investor wants the preference, careful amendments must be made to the articles.

Other investors and shareholders may not be fully supportive because the amount of the desired preference will not have ever been received by (nor directly benefited) the company (in contrast to funds received and a preference given on a primary investment).

12. Do the transfers happen on a platform or exchange?

No.  These are OTC – over-the-counter – trades agreed privately between willing buyers and sellers.

In recent years, platforms have sprung up in the US – Forge Global, EquityZen, Nasdaq Private Market (formerly SecondMarket) – and elsewhere to provide formal exchanges for secondary share sale trading. 

13. Does the UK have one? What’s this I hear about PISCES?

Not yet. But it’s coming soon.  The ‘Private Intermittent Securities and Capital Exchange System’ will be a new type of private stock market – described by the FCA as ‘private-plus’ – where platforms permit shares in participating private companies to be acquired by participating investors during intermittent trading windows.

The first platforms are expected to start trading later on in 2025, with the London Stock Exchange building one of them and said to be courting some of the leading UK tech companies to participate.

Whether you are buy side, sell side or a director of a company thinking about a secondary sale, our series on PISCES is well worth a read.

14. If it’s OTC, then what about execution and financing risk?

You mean what happens if the seller signs and delivers the SPA and the stock transfer form and yet the buyer won’t or can’t pay the purchase price (and then tries to register the transfer)?  The buyer would be in breach of the SPA, but in the meantime might get the form stamped by HM Revenue & Customs and present it for registration to the directors.

It’s a good question because the articles of association of the company likely won’t say that the directors need to see the SPA, and will likely say that if the directors are presented with the stock transfer form they need to register the transfer – subject of course to those points above about restrictions on transfer and only if the form has been stamped – but likely not needing to see whether or not the buyer has actually paid the purchase price, which is a matter between the buyer and seller.

In close companies where there are high levels of trust and familiarity, this risk might be acceptable.  If not, some escrow type arrangement will be needed or some completion process organised using a solicitor’s client account.  Solicitors in the UK can’t use their client accounts as banking facilities (which would include running a true escrow service), but they can handle and distribute the proceeds of sale on which they are advising.  As such, funds could be held on account on undertaking, documents signed but held to order and then both released simultaneously on a completion. 

15. What’s this term ‘tail gunner’ I sometimes hear about?

If a seller has the leverage, it could ask for a ‘tail gunner’ clause to say that if the buyer sells the shares on for a much larger price within a specified period then the price gets adjusted.

This is not common to see and is complex and therefore expensive to draft in properly in the SPA.  If the seller is not part of management, however, and worries that they will sell only to lose out as a result of subsequent events that management know might perhaps occur (a well-heeled buyer coming in from the wings perhaps), they it might want to ask for that tail gunner nonetheless.

This piece was written by Henry Humphreys with assistance from Alina Merchant Mohamed.  If you have questions or queries about secondary share sales and related issues, then do please reach out to them or to another member of the HLaw team.

All the thoughts and commentary that HLaw publishes on this website, including those set out above, are subject to the terms and conditions of use of this website.  None of the above constitutes legal advice and is not to be relied upon.  Much of the above will no doubt fall out of date and conflict with future law and practice one day.  None of the above should be relied upon.  Always seek your own independent professional advice.

Humphreys Law