A Second Market Is Emerging

Claire Cain Miller has a story in today's NY Times about Second Market, a NYC based company that makes markets in illiquid securities. She reports that they will shortly be launching a marketplace for private company stock.

I've written about this idea in the past and I think it is badly needed. Not everyone can wait until the exit comes or the IPO market comes back. We are seeing a lot of founders selling portions of their stock privately, mostly to the other investors in their companies. But that is not a transparent or particularly liquid market and it is not clear that the founders or the investors buying their shares are getting a fair deal.

A better idea is to create a marketplace where sellers and buyers can meet and where both sides can get price discovery. When you know the latest prices and can get a price history, you can be more confident of your purchases.

Last week Mike Arrington wrote a post on Facebook turning down an offer to invest at a $2bn valuation. I left a comment on that post saying that I thought that $2bn price was low given the prices being paid in the Facebook secondary market. Later that day, I got a private email with a price chart for Facebook common since January 2008. I was asked not to publish that chart so I won't. That chart showed that Facebook common has traded as low as $6/share earlier this year but is now trading around $8/share. That translates into $3bn to $3.5bn, lower than I had suggested in my Techcrunch comment.

Seeing that chart was a real "aha moment" for me. There is enough activity in Facebook common that we can tell at any time what the market price is and we can also see how that price has changed over time. Like I said in a post last week, it's like Facebook is a public company without really being public.

I understand that there are issues with this development. It will be harder to strike options at low prices when the company's stock has a price history. It will be harder to control who the shareholders are and it will be harder to keep employees motivated to stick around if they can cash out early. These are all problems companies usually don't face until they go public. Now they will have to face them earlier.

But I still think this is a really good idea. Claire talked to me about this story and I told her:

Entrepreneurs won’t start companies and investors won’t invest in them
if there is no path to liquidity on the company stock. A secondary market for private company stock can
fill the gap that the lack of an I.P.O. market has created.

I don't believe that the secondary market will replace the public markets and M&A as the primary liquidity options for venture backed startups. I think it's a third choice that we need. And I think it represents a tier in the market that is missing between venture capital and the public equity markets. There are about a half dozen other startups working on creating markets of this kind and I expect we'll see all of them launching in the next six months. I hope that one or more of them makes it and that we'll develop a robust, liquid, and transparent secondary market in the next few years. I know we need it.

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