पाठशाला Pathshala · धन Dhan, Money · Lesson 24 · Scale

Secondaries: liquidity for founders and employees before the exit

A secondary sale turns some paper into money for founders, early employees and angels years before an exit. In India it works when price, approvals, exchange control and tax are settled before anyone signs.

Pathshala, The Founder Library · 11 October 2026 · 7 min read

Seen from above, people spread harvested rice to dry on fields in Habra, West Bengal. — Photograph: Dibakar Roy · Pexels

A founder can be worth a great deal on paper and still be worried about rent, a parent’s hospital bill or a home loan. An engineer can hold options worth several years’ salary and be unable to use any of it. A secondary sale fixes both, years before an exit, if it is priced and papered properly.

This lesson covers why secondaries happen and why investors allow them, the four shapes they take, how to price one, the approvals and the exchange control rules, the tax (with a figure that turns a price into money in hand), and the process.

Why secondaries happen, and why investors allow them

In a secondary sale an existing shareholder sells shares to a buyer; the company receives nothing. Investors once resisted founder secondaries because a founder with money in the bank was thought to be a founder with less hunger. The view has softened for a practical reason: a founder whose family finances depend on the company’s next round makes worse decisions about that round, taking the safer price, the quicker sale or the investor who pays now. A modest sale that removes that pressure aligns the founder with the long game.

The same logic applies to employees, whose options are part of their pay and are worth nothing until they can be sold. A company that offers a liquidity window every couple of years can recruit against companies that pay more cash, and keeps people who would otherwise leave to realise their gains somewhere else. And new investors often want more ownership than the company wants to issue in a primary round. Buying some shares from early holders gives them the stake without diluting everyone further.

The four shapes

A founder sale alongside a primary round. The incoming lead buys a small part of the founders’ holding at the same time as it invests in the company. It is the simplest form, because the price discovery and diligence have just been done. Keep it small enough that the founders’ incentive is untouched; the question every later investor will ask is how much of their holding the founders sold, and why.

A combine harvester cuts a golden wheat field seen from directly above. — Part of the field is cut and part still stands. Decide in advance how much each seller may bring in. Photograph: Bekir Umut Vural · Pexels

An employee liquidity programme. The company arranges for one or more buyers, usually existing or new investors, to buy shares from eligible employees at a set price within a set window. The rules decide who may sell (tenure, vested status) and how much (a share of vested holdings), so that the programme rewards long service without emptying the team of its owners.

An early-investor clean-up. Angels and small funds from the first rounds sell to a later investor, often at a discount, which shortens the cap table and gives early backers a return. It is usually welcome on both sides.

A buyback by the company. The company itself buys shares back from holders, using its own cash. It is governed by the Companies Act and has its own limits, approvals and tax treatment, and it spends money the company may need. Use it when the company has surplus cash and the shareholders want to sell; take advice on the current tax treatment first.

Pricing: the discount and the signal

Secondaries of ordinary shares usually price below the last round’s preference share price, because ordinary shares carry none of the preferences, anti-dilution rights or protective provisions the investors bought. The size of the discount is a negotiation, but it is also a signal. A modest discount says the shares are worth roughly what the last round said. A deep one invites every later investor to treat the secondary price as the real valuation. Founders should keep the discount modest and the volume small, and avoid running a secondary at a price far below the last round shortly before raising the next one.

Two rules set floors and ceilings in India. Where a resident sells to a person resident outside India, the Reserve Bank’s Master Direction on foreign investment requires the price to be not less than the fair value worked out by an internationally accepted pricing method and certified by a chartered accountant, a SEBI-registered merchant banker or a practising cost accountant; where a non-resident sells to a resident, the price must not exceed that fair value. The transfer is then reported on form FC-TRS. And the tax rules, below, penalise a sale far below fair market value on both sides of the table.

Approvals: the paper that decides who may sell

Before any price is agreed, read the articles and [the shareholders’ agreement](/library/shareholders-agreement-what-you-are-signing). A founder’s shares are often subject to a lock-in and to investor consent for any transfer; existing investors usually hold a right of first refusal (to buy the shares first at the same price) and a tag-along (to sell alongside the founder on the same terms). Each must be offered or waived in writing. The board approves the transfer, and the share transfer is executed and recorded under the Companies Act. Leave a month for this.

Employees cannot sell options. Rule 12 of the share capital rules says options granted to employees are not transferable, so an employee must exercise, pay the exercise price and receive shares before selling them. Exercise is itself a taxable event: the Income Tax Department treats the fair market value on the exercise date less the amount paid as a perquisite taxed as salary. For an eligible startup, tax deduction on that perquisite can be deferred until the earliest of 48 months after the end of the assessment year of allotment, the employee leaving, or the sale itself, so a secondary brings the deferred tax due. A good programme arranges a cashless exercise, with part of the sale proceeds paying the exercise price and the tax.

Tax: from the price to the money in hand

For a seller, the gain is the sale price less the cost of the shares. For a founder that cost is usually the face value paid at incorporation; for an employee it is the fair market value on the date of exercise, and the holding period runs from the date of allotment. Under the changes explained in the Finance Ministry’s memorandum to the 2024 Finance Bill, unlisted shares held for more than 24 months are long-term assets and the gain is taxed at 12.5 per cent without indexation, for transfers from 23 July 2024; shorter holdings are taxed at the seller’s normal rates.

The Indian twist is the fair value rule. Section 50CA of the 1961 Act, described in the same memorandum, takes the fair market value of unquoted shares as the full value of consideration when the sale price is lower; the seller is taxed as if paid fair value. On the buyer’s side, receiving shares below fair market value can be taxed under section 56, for which Rule 11UA values unquoted equity shares mainly from the balance sheet. For most loss-making startups that book value is far below any secondary price, so the rule does not bite; for a profitable or asset-rich company it can. The Income-tax Act 2025, in force from 1 April 2026, replaced the 1961 Act and, the Central Board of Direct Taxes says, did so without altering the underlying tax policy; check the new section numbers with an adviser.

Take a founder selling 20,000 shares at a 25 per cent discount to a last-round price of ₹1,000, so ₹750 a share and ₹1.5 crore in all. With a cost of ₹10 a share and a holding of more than two years, the gain is ₹1.48 crore and the tax at 12.5 per cent about ₹18.5 lakh, leaving roughly ₹1.31 crore before surcharge and cess. Move the holding under 24 months, or the fair market value above the sale price, and watch what changes.

Sell enough to stop worrying about money and not so much that anyone wonders whether you still care. Then settle the paper and the tax before the price is announced.

Running a secondary, step by step

Agree the purpose first, in writing, with the board: founder liquidity, an employee window or a clean-up, and the maximum each seller may sell. Get the buyer’s indicative price and test it against the last round and the next one. Read the articles and the shareholders’ agreement, list every right of first refusal, tag-along, lock-in and consent, and send the notices. Obtain the valuation certificates the pricing rules and the tax rules need. For employees, publish the eligibility rules, arrange cashless exercise and a tax note for each participant. Sign, transfer, record and report, including FC-TRS where a non-resident is involved. Tell the team and the investors what was done and why. Review the programme once a year and decide whether to open another window.

Nothing here is legal, tax or investment advice. The tax rates, the fair value rule and the foreign exchange pricing rules were checked on 10 October 2026; have every secondary reviewed by a chartered accountant and a lawyer before signing.