What is Secondary Liquidity?

Secondary liquidity refers to the ability of IPO investors to sell shares in the secondary market, that is, to buyers on a public stock exchange. The primary market consists of those institutional investors who buy the issued shares directly from the underwriter and/or syndicate of brokerages.

Understanding Secondary Liquidity

When a company goes public, the underwriting investment bank and/or syndicate of securities dealers sell initial shares to the primary market, mostly institutional investors. These investors may then want to sell those shares in the secondary market, where it is purchased by retail and institutional investors. Secondary liquidity is generally used by investors and founders in order to cash out on their equity in a company.

The secondary market typically refers to transactions that occur on a public exchange. Secondary transactions can occur privately as well when an equity investor sells its commitment to a private equity fund or an alternative investor. These equity holdings are much less liquid than those acquired via public exchanges and are typically intended to be held over the long term.

From a regulatory perspective, secondary liquidity presents a number of challenges. Some of them include the absence of transparency and information regarding the finances of a concern and illiquidity or lack of enough participants in a secondary market to conduct trades. Secondary liquidity also does not come with the same set of protections available to investors who liquidate their holdings in public markets.

Key Takeaways

  • Secondary liquidity refers to investors selling shares in the secondary market, that is, to buyers on a public stock exchange.
  • Secondary liquidity is generally used by investors and founders to cash out their equity in a concern.

Example of Secondary Liquidity

Suppose a founder urgently needs funds for personal use. Then she can sell a portion of her equity holdings in a company in secondary markets to raise the necessary amount. Another example of secondary liquidity occurs in the case of rising valuations for startups. Ridesharing company Uber was one of the hottest startups for investment in recent times. Several early investors in the company, such as Benchmark Capital and First Round Ventures, cashed out some or all of their stake in the startup in January 2018. Japanese private equity firm SoftBank Group Inc. purchased their holdings as part of its investment in the company.