Most venture-backed companies have transfer restrictions in their bylaws, stockholder agreements, or investor rights agreements that limit the ability of stockholders to sell shares without company consent. The most common restrictions include rights of first refusal (ROFR) requiring the company or existing investors to have the first opportunity to purchase shares on the same terms offered by a third-party buyer, and co-sale or tag-along rights allowing investors to participate proportionally in any sale by a founder or key holder. Gurpreet Bal advises sellers to review all applicable agreements before initiating any secondary sale process, as failure to comply with transfer restrictions can render the transaction void and create governance complications.
Pre-IPO shares are restricted securities under the Securities Act of 1933. Secondary sales must be conducted under an applicable exemption from registration. Common exemptions include Rule 144 (available only for shares of SEC-reporting companies, which most pre-IPO companies are not), Section 4(a)(1) (the basic exemption for sales by persons other than issuers, underwriters, or dealers), Section 4(a)(7) (added by the FAST Act in 2015, providing a safe harbor for secondary sales to accredited investors), and Regulation D private placement exemptions. The seller must ensure the buyer is an accredited investor, appropriate investment representations are obtained, and stock legends are maintained. Gurpreet S. Bal advises sellers and companies on structuring secondary transactions to comply with applicable securities exemptions and state blue sky requirements.
Pre-IPO secondary sales are typically priced at a discount to the company's most recent primary financing round price, reflecting the illiquidity of private shares and the lack of a public market. Discounts of 10% to 30% from the last round price are common, though the discount varies based on the company's proximity to an IPO, the size of the block being sold, and market conditions for the company's sector. Information asymmetry is a significant concern because sellers who are insiders may possess material nonpublic information about the company. Gurpreet Bal advises companies facilitating secondary programs to establish information barriers and require seller representations regarding the absence of material nonpublic information to protect both the company and the buyer.
The tax treatment of a pre-IPO secondary sale depends on the type of equity being sold, the holding period, and whether the stock qualifies under Section 1202 QSBS. Shares held for more than one year are eligible for long-term capital gains treatment. Shares acquired through ISO exercise require careful analysis of the one-year-from-exercise and two-year-from-grant holding periods for favorable capital gains treatment. Critically, QSBS eligibility under Section 1202 may be affected by a secondary sale because the exclusion requires the stock to be acquired at original issuance. A buyer in a secondary transaction does not acquire the seller's QSBS status. Gurpreet S. Bal advises founders contemplating secondary sales to evaluate the QSBS implications carefully, as selling QSBS-eligible shares before the five-year holding period is satisfied permanently forfeits the Section 1202 exclusion for those shares.
The first question Gurpreet asks is: what is the goal? And then he interrupts whatever is about to come out of the founder's mouth next — because that first answer is almost always the version they would tell their investors or their employees. What he actually wants to know is the real goal. Not the sanitized one. That conversation does two things simultaneously: it confirms that the founder is thinking about this as a fiduciary to the company even in cases where they are participating personally in the sale, and it allows an honest assessment of whether what they are proposing will actually produce the result they want — given transfer restrictions in the investment documents, tax consequences they may not have modeled, and timing constraints relative to the IPO path. The gap between what a founder thinks a secondary sale will accomplish and what it will actually accomplish, when you run it through the full set of constraints, is often significant.
Gurpreet S. Bal is a Partner at Foley and Lardner LLP in Silicon Valley, where he advises startups, founders, and investors on venture financings, M&A, IPOs, and corporate governance. He has represented clients in hundreds of transactions with aggregate deal value exceeding $60 billion across AI, semiconductors, fintech, and emerging technology. Gurpreet's recent IPO experience includes leading company representation in the only sub-$1 billion U.S. semiconductor IPO in recent years.