San Francisco: Founders of start-ups and the venture capitalists who finance them have two ways to get their money out of the company: sell it to another company or sell shares to the public.
What if they had another option?
SecondMarket, which operates markets for trading illiquid assets online, is creating a marketplace for trading shares of private companies. It puts investors together with shareholders and collects a fee, which will be 2% from each side.
SecondMarket, originally called Restricted Stock Partners, was founded in 2004 by Barry E. Silbert, 32, a former investment banker who specialized in financial restructurings. He hatched the idea for a marketplace for illiquid assets after creditors awarded shares of debtor companies by bankruptcy courts approached him looking to sell these shares.
The founders of SecondMarket say that in the last several months they have been getting an increasing number of calls from shareholders, including employees, founders and investors, who want to sell their stakes in tech start-ups, including Facebook Inc., Twitter Inc., LinkedIn Corp. and Tesla Motors Inc. The company believes there is a demand because it has privately brokered about 50 trades.
The creation of a vibrant market in unregistered securities of private companies that reveal scant financial information has its doubters.
“This will not be a third exit, not in the near term,” said Roger Ehrenberg, a former investment banker and hedge fund chief executive who now runs IA Capital Partners, his angel investment fund. “Just like we’ve seen a very limited or non-existent IPO (initial public offerings) market, it stands to reason that these buyers would be the same kinds of investors, so I’m not at all convinced that the demand side is even there.”
For one thing, it could be a thin market, on both sides of the trade. The US Securities and Exchange Commission (SEC) allows the trading of unregistered securities, but only for select investors. The new market will be open only to accredited investors and qualified institutional buyers, which SEC defines as financially sophisticated enough to invest in high-risk securities about which there is little public information.
Even if individual shareholders and venture capitalists do trade on the exchange, it will be hard for it to grow, Ehrenberg said. There is only a small universe of such wealthy, risk-tolerant investors, he said, and companies are limited to 500 shareholders before they have to file with SEC as if they were public.
“For this market to really develop real liquidity, that rule needs to be changed, but right now, the government needs to do the exact opposite,” Ehrenberg said. “They don’t want more people to buy illiquid, unregistered investments—they want maximum transparency.”
Although the securities are unregistered, fraud may not be a big worry. SecondMarket says it verifies with the company and its lawyers before any shares change hands.
“There is no risk that investors wire money and don't own the stock or the company doesn’t exist,” Silbert said. The public nature of the market may also serve to discourage swindlers.
There have been other efforts to create exchanges in which investors can trade shares of private companies, including Nasdaq Portal Alliance and smaller efforts such as XChange and Nyppex.
SecondMarket thinks it has an advantage because it has successfully created markets in other illiquid asset classes—it says it has 3,000 investors and has completed $1.5 billion in transactions—and because it has a staff of 100 that handles research and legal issues.
©2009/THE NEW YORK TIMES