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Primary investments are when LPs commit capital to a fund or company at the time of issuance of the equity. Investors buy (1) “blind pool” stakes in a fund or (2) participate in a financing round for a private company.
(Blind pool risk = you don’t know the exact companies you invest in when investing in a fund; you basically trust the GP is competent)
Secondary investments are when you purchase existing stakes in private funds or companies from the current owners of the equity. Secondary buyers receive pro-rata cash flows (known as distributions) and also avoid the blind pool risk.
Secondaries are resales of existing fund stakes or company shares, and they mainly offer liquidity and portfolio management to primary investors, allowing them to rebalance or exit investments.
The company creates new shares and sells them to investors. The money goes directly in the company’s bank account.
If you take the shares from an existing investor, there is no dilution or change in the ownership % of investors. If you buy newly issued shares, founder and existing shareholders get diluted, as their ownership % decreases (all other things equal), but the company has more cash to grow.
Types of shares that can be issued:
Common shares: Typically held by founders, employees (via ESOPs), and early team members. They are the last to be paid in a liquidation, usually don’t have special protections, and have voting rights. Basically, if a company exits at a low amount, common stockholders may receive nothing if preferred investors absorb the proceeds through their liquidation preference.
Preferred shares: Usually issued to investors in primary funding rounds (Series A, B, C, etc.). They are called “preferred” because they have special rights and downside protections. The main point is that in case of liquidation, they get paid before common stockholders.
Key features:
(1) Liquidation preference (downside risk protection): Preferred stockholders get their money first with a certain preference multiple. (All the following are considered “convertible preferred stock”)
1x Non-participating Preferred (founder-friendly): The investor gets 1x their initial investment first OR they can convert into common, depending on which gives them more money. Protects against downside protection but avoids double-dipping.
Example: Investor puts €10m. If the company sells for €12m → They take €10m (preference). If the company sells for €200m → They convert to common and take their ownership percentage.
Participating Preferred (investor-friendly): The investor gets 1x their initial investment AND also participates in the remaining proceeds as if they were common shareholders. “Double dip” option.
Example: Investor owns 20% and invested €10m. Company sells for €100m. Step 1: Investor gets €10m back. Remaining = €90m. Step 2: They also get 20% of €90m = €18m. Total = €28m.
Multiple Liquidation Preference (2x, 3x, etc.): Investor gets x times its initial investment before anyone else gets paid. This is aggressive and usually appears in down rounds, distressed companies, or structured growth deals.
Capped Participating Preferred: Investor can double-dip, until a certain cap, like max reaching 3x its initial investment, then stops. Kind of a compromise structure.
(2) Conversion rights: If better for them, preferred stock can be transformed into common stock. If the company sells for a large amount, they convert and share in the upside.
(3) Anti-dilution protection: If the company raises money later at a lower valuation, preferred shareholders may get price adjustments to protect them. An anti-dilution clause protects early investors if the company later raises capital at a lower valuation. In a full ratchet mechanism, the investor’s conversion price resets fully to the new lower price. In a weighted average mechanism, the adjustment depends on the number of new shares issued and is less punitive. Weighted average is more common in venture transactions.
(4) Voting & Control rights: Preferred stockholders may have board seats, protective porvisions, veto rights over certain decisions. Commons have less control.
Capital stack logic for funding rounds: Later funding rounds get paid before earlier ones. For example, Series C gets paid before Series B, which gets paid before Series A, and then the common. The later the series, the more senior in liquidation.
Other types of preferred shares:
Preferred with Dividends: Some include dividends, but they are usually non-cash, accrued, and paid only at exit. More common in GE, down rounds, structured deals. Less common in early VC.
Example: Investor invests €10m with: 1x liquidation preference and 8% cumulative dividend. After 5 years, the preference might grow to: €10m × (1.08)^5 ≈ €14.7m. Now they must receive €14.7m before Common gets anything.
Preferred with Redemption Rights: After a certain number of years, the investor may ask for a share repurchase. (If there is no exit, you give me my money back). More common in late-stage GE, mature companies, and structured investments.
LP-led secondaries: An LP sells the interests he owns in one or multiple funds to secondary buyers.
GP-led secondaries: The GP initiates a transaction (mostly through a Continuation Vehicle/CV) for one or multiple assets, which gives the LPs the option to liquidate their investments or roll over into the new SPV.
(1) Continuation vehicles: The GP takes one or multiple companies from the current fund and puts them in a new fund (the CV). New investors bring in new money in the CV, while old LPs can cash out their positions or choose to roll over their investment. The GP would want to do this because he thinks one or more investments still have upside potential outside the current holding period.
(2) Strip sales: The GP sells a small % (usually 20-30%) of one of the fund portfolio companies to a secondary investor. The fund keeps control of the investment, but gets liquidity, reduces risk, and can return some money to the LPs.
(3) Stapled transaction: This is when a secondary investor both invests in the new fund/SPV and also commits to invest in the next fund created by the same GP. The deal is stapled together (old fund purchase + investment in new fund). For the GPs, this means that they are both provided liquidity and raising funds for the new vehicle at the same time.
(4) Fund recaps: Financial restructuring of the fund’s assets. It can mean bringing in new investors, adding debt, or changing the capital structure, so changing the type of financing of one or more assets.
(5) Preferred equity: In a preferred equity transaction, a secondary investor gives capital directly to the fund, not to a specific company. In return, they don’t get normal equity upside like traditional LPs. Instead, they receive priority repayment from future exits, meaning they get their money back first, plus an agreed return, before the regular LPs receive profits. Their return comes from the cash generated when the fund eventually sells its portfolio companies. So it’s a way for the fund to raise liquidity without selling assets, and for the investor to earn a more protected, structured return.
(6) Tender offers (more common in venture): An investor offers to buy shares from early employees, investors, and sometimes LPs. It’s a voluntary liquidity event.
(7) NAV loans: The fund borrows money using its portfolio as collateral. Reasons may be to distribute cash to LPs or to support portfolio companies.
Company-led secondaries: The company itself organises a process where early employees, investors, and VCs can sell their stakes, through a new funding round or a standalone liquidity event. The company handles it so it can control who owns the shares and keep the cap table clean.
Direct secondaries: An investor buys shares from an existing investor directly, without the company getting involved, although it may need its approval.
(1) Portfolio diversification: Secondary portfolio are typically broadly diversified by sponsor, fund, sector, strategy, geography, industry, company, and vintage year, which in turn lowers the volatility.
(2) Mitigation of the J-curve: The J-curve effect of primary investments is mitigated as you are purchasing the asste closer to their harvest stage with even a potential discount to NAV, which further protects the investors vis-a-vis downside risk.