Are you an investor looking to transfer your interest in a company or fund to another investor? If so, then you may want to consider a secondary transaction. How does it look like, and what are the steps involved for shares of a company as opposed to interests of a fund? This article will cover the legal aspects of a secondary transaction.
The Rise of Secondary Transactions
In recent years, secondary transactions have exploded in popularity. Motivations behind them vary. Exits can take years, and sellers may want to get out of their investments early to liquidate or reallocate their capital. Buyers may see opportunities with companies or funds that were carefully vetted already, especially when sellers have a strong track record for investing. In down markets, secondary transactions offer stability when compared to brand new investments.
Despite the benefits, because secondary transactions are a fairly recent trend, prior legal documents normally do not cover them in detail. Clauses on transfers of shares or interests are simplistic and often contain little or no information on secondary transactions. As we will see in the sections to follow, sale and purchase agreements are based more on custom than on anything written, both in the internal documents of the company or fund in question or in the law.
Secondary Transactions For Companies
Secondary transactions for companies are typically quite straightforward. Most incorporation documents provide for transfers, even if they are not covered in any detail. The shareholder agreement may include transfer restrictions such as the right of first refusal, drag along rights, and piggyback rights. Board and shareholder approval may be required.
As for other considerations, the incorporation documents may require that securities filings be made for any transfers made outside of a financing round. If securities filings must be made, they are usually made pursuant to Regulation D, which can be done in a day.
Investors looking to sell their shares should consult with the shareholder agreement to learn about the applicable transfer restrictions for the secondary transaction. One particularly limiting restriction is the right of first refusal, which can delay the date of the sale by months and leave the buyer dry if any existing shareholders decide to exercise this right. Any transfer restrictions should be communicated to the buyer beforehand so that they can have reasonable expectations of the terms and conditions of the sale.
Secondary Transactions For Funds
Secondary transactions for funds can be more complicated, depending on the type of interest being offered for sale. If the interest being offered is an interest in the fund, then the process is simpler. All an investor and buyer need to look at are the transfer clauses in the operating agreement (in the case of an SPV) or limited partnership agreement. The transfer clauses may contain the same restrictions as those found in the incorporation documents of companies, or they may contain additional restrictions. Approval by the fund manager may be required. In any event, because fund managers usually have significant autonomy, the approval process is simpler than the formal resolutions of boards and shareholders in companies.
The fund may be required to do a securities filing in the same manner as a company. Regulation D is the easiest way to go, but other filings may also work if the secondary transaction is part of the fundraising activities of the fund pursuant to those filings.
If the interest being offered is an interest in a portfolio company, then the process is requires two layers of approvals. The first layer is the portfolio company, with approval of the transfer made through the process outlined in the previous section for companies. The second layer is the fund, which must internally approve the transfer of interest from the selling investor to the third party buyer. At the fund layer, the selling investor must follow the same protocol as that typical of funds, which involves reviewing the operating agreement or limited partnership agreement.
In A Nutshell
Investors looking to sell their stakes in companies or funds as part of their general investment strategy should review the formation documents of the businesses that they invest in beforehand so that they can plan out future secondary transactions. Investors looking to offload their stakes for simpler motivations can take advantage of gaps in current legal documents on transfers. Because legal documents don’t contain much on secondary transactions, buyers and sellers can negotiate their deals in a flexible way. Secondary transactions are thus another way for businesses and investors to raise capital and increase liquidity.
