What to Know About Secondaries and Legal Transfer Rights
The secondary market for private fund interests—commonly known as "secondaries"—has become an essential feature of venture capital (VC), private equity (PE), and growth equity ecosystems. As liquidity demands among Limited Partners (LPs) increase, understanding the legal intricacies of secondary sales and transfer rights is critical for fund managers, LPs, and startup founders involved in secondary transactions.
This article offers a comprehensive legal overview of secondary transactions, key transfer rights, and best practices for navigating liquidity events in private markets.
What Are Secondaries?
Secondaries refer to the sale of existing interests in a private investment fund, company, or portfolio. Unlike primary fundraising, which involves issuing new securities, secondaries involve the transfer of previously issued ownership interests from one investor to another.
Types of secondaries include:
LP Secondaries: Sale of LP interests in a fund
Direct Secondaries: Sale of company shares (e.g., founder or employee equity)
Structured Secondaries: GP-led transactions like continuation funds
Why Secondaries Matter
Liquidity: Offer exit opportunities for early investors or employees
Portfolio Management: Allow LPs to rebalance investment allocations
Pricing Transparency: Provide valuation benchmarks for otherwise illiquid assets
Fund Restructuring: Help extend fund lifecycles through GP-led solutions
Legal Considerations in Secondary Sales
1. Transfer Restrictions in Governing Documents
Most LPAs, shareholder agreements, or operating agreements impose restrictions on secondary transfers, including:
Consent Requirements: GP, company board, or existing LP consent needed
Right of First Refusal (ROFR): Existing investors may have first right to purchase
Co-Sale Rights: Minority investors can sell alongside
Tag-Along and Drag-Along Rights: Protect minority interests or facilitate group sales
Tip: Always review governing documents carefully before initiating a transfer.
2. Regulatory Compliance
Secondary transactions must comply with:
Securities Laws: Transfers must qualify for exemptions from registration (e.g., Regulation D, Rule 144)
Form D Amendments: May be required if fundraising disclosure changes
Investment Company Act Considerations: Ensure compliance with ownership thresholds
External Link: SEC Secondary Market Compliance Overview [https://www.sec.gov/smallbusiness/exemptofferings/secondary-sales]
3. Documentation Best Practices
Assignment and Assumption Agreements: Legally transfer ownership rights
Amended Subscription Agreements: Update fund records to reflect new investors
Consent Letters: Formalize all required approvals
Ensure that legal counsel reviews all transfer documentation to avoid future disputes.
GP-Led Secondary Transactions: Unique Legal Issues
GP-led secondaries, including continuation funds and tender offers, introduce additional complexity:
Fiduciary Conflicts: GPs must balance duties to both selling and continuing LPs
Valuation Disclosure: Transparent third-party valuations are critical
SEC Oversight: Increased scrutiny under new Private Fund Adviser Rules
Tax Implications of Secondary Transfers
Allocation of Gains and Losses: Determine cut-off dates for profit allocations
Withholding Tax Obligations: Particularly relevant for transfers involving foreign investors
IRS Reporting: Update Schedule K-1 allocations accordingly
Consult tax advisors early in the process to minimize adverse tax consequences.
Key Risks in Secondary Transactions
Broken Deal Costs: Legal and administrative costs if the transaction fails
Disclosure Risk: Incomplete or misleading information to buyers can trigger liability
Consent Delays: Lengthy consent processes can jeopardize deal timelines
Secondary Market Trends
Increased LP-Led Sales: Driven by portfolio rebalancing and liquidity needs
Rise of GP-Led Transactions: Especially in private equity and late-stage venture
Use of Specialist Platforms: Such as Forge Global, Nasdaq Private Market, and CartaX
Navigate Secondaries with Legal Precision
Secondary transactions offer valuable liquidity but require careful legal navigation to avoid regulatory pitfalls, documentation errors, and conflict of interest challenges. Understanding transfer rights, securing required consents, and ensuring regulatory compliance are essential to successful execution.
For legal support structuring and executing secondary transactions or navigating transfer rights under fund documents, contact our private fund legal team at 786.461.1617 to schedule a consultation and safeguard your secondary market strategy.