When you hear about shares of Facebook, Twitter, Groupon, LinkedIn, Zynga, Pandora, Yelp, and others selling on so-called “private company markets,” the frenzy of getting to invest into high-growth private companies that could be “the next Google” can be sky-high. A quarterly report has come from SecondMarket that is shining a light on how active this marketplace for private companies is. Don’t say you did not hear this down the road… The report also highlights just how small the market is.
SecondMarket said in its report on Tuesday that its first quarter share volume was $115.4 million in private company stock transactions. While this is listed as being some $600+ million since its launch in 2009, investors need to know that this really feels like a loose representation of a company value rather than a true market value being solidified. Liquidity is far from king here, and this whole $115.4 million would be the size of maybe just one fairly active OTC Bulletin Board stock if you tally up the entire dollar volume of a single quarter.
The mix of buyers on SecondMarket by transaction has shifted but may be too small to be considered a trend. High net worth individuals were 59% of the completed transactions in the first quarter, but that figure was only 18% of the Q4-2010 period. Venture capital funds led in the fourth quarter of 2010 with 43% of the completed transactions, but that was zero in the first quarter. SecondMarket attributed the high net worth trends to private companies becoming more open to individual investors, lower rights of first refusal, and by allowing more individual investment purchases to close. Another jump was attributed to market efficiencies in auction and settlement processes with lower prices.
Some food for thought….
- The Top 17 IPOs to Watch in 2011
- LinkedIn valuation jumped to over $4.2 billion ahead of IPO
- Facebook talks to underwriters
Just because this is still rather small and just because this is an emerging pre-IPO market, there should be no question that the market is a highly relevant one. This helps to establish a guide for some value at any given time. The problem is that the value may not be truly representative of the real value of a company.
Ask yourself this… Is Facebook worth $80 billion, or is Groupon worth $25 billion today? The answer depends upon whom you ask. If you are a venture buyer that wants in ahead of the IPO then the answer is yes. If you are trying to evaluate this on what an underwriter and what a real IPO will value the company at when millions or billions of dollars have to support the entire market values, then maybe not.
Where SecondMarket first came on our radar was in its ability to allow owners of structured financial products to buy and sell securities with each other. Remember those collateralized debt obligations? There were also bankruptcy claims that could be bought or sold. Another aspect where it has had many offerings has been in restricted securities that are actually based upon public company shares or other public securities.
An equity is supposed to be an equity if all things are equal. What happens to the value of this exchange mechanism if the market drops 10% in a month? What happens if the IPO market closes for a while? What happens if one seller is willing to sell shares too cheap? Any of these issues can wreck a single company or maybe even a whole group of them.
There will be a day that another recession comes back or another bear market comes back. It is just part of the business cycle. When private company sellers either cannot sell or when they start selling shares at levels so low that it harms the underlying private companies, don’t be shocked about the backlash against these public-private markets.
The SEC has looked into these private security markets for a while now and how they will be treated in the years ahead still remains a question. If the public gets into these markets in a meaningful way and the liquidity dries up and losses or lock-up of capital prevails, then the scrutiny is likely to only increase. If this effort actually does set better benchmarks and does actually free up capital in private company shareholders, then the SEC is likely to be far more friendly.
The private company markets (or public-private markets) do actually offer a rather unique service. There are just some serious caveats attached.
JON C. OGG