A Secondary Market For Private Company Stock

The news that some Facebook employees are selling their stock privately naturally focuses on the price/valuation (a deep discount to the $15bn that Microsoft paid).

First of all, a deep discount makes sense. Most privately held venture backed companies now regularly value their common stock for the purposes of issuing stock options at fair value. These valuations are often done by third parties and are called 409a valuations. I see many 409a valuations every year and most value the common stock at somewhere between 20% and 50% of the last round’s preferred stock price.

So if Facbook employees are selling stock at company valuations between $3.75bn and $5bn, that makes sense. It’s 25% to 33% of the valuation Microsoft paid.

And many have said, including me, that Microsoft’s $15bn valuation was a premium to what Facebook would have gotten and should have gotten in a truly market based deal. Microsoft wanted a strategic relationship with Facebook and was prepared to pay a premium for it. Some have suggested it was even to Microsoft’s benefit to put a premium valuation on Facebook so it would not get bought cheap by someone else. I am not sure about that last part, but it’s clear to me that a financial investor (and the public markets) would value Facebook at somewhere around $7bn right now (maybe less).

So if $7bn is a better approximation of the market value in a financial transaction, then the $3.75bn to $5bn private sale prices make even more sense. They represent 50% to 75% of "fair value". And those kind of discounts are what buyers of secondary private shares usually demand. They are purchasing stock that cannot be resold easily and they are becoming shareholders in a company that they will have basically no ability to control or impact.

All of this said, I think this is a great thing. I have said before that we need a more active secondary market for founder shares and shares purchased by early investors in venture backed companies. As exits via IPO and M&A become more and more difficult, I sure hope the secondary market will step in to fill the gap.

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