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.


Zemanta Pixie
#VC & Technology

Comments (Archived):

  1. stevenloi

    Thanks for revisiting this topic, Fred. I was actually digging for the old posts and re-reading re: the secondary market idea a couple days earlier that you wrote about (and in which Charles Hudson’s blogged in response to). LinkedIn made news with this as well. It’s great for the earlier employees to get this opportunity and keep them working hard.

  2. agawley

    Interesting to hear about these facebook transactions.In terms of developing this secondary market, I’m not sure where it would end up sitting. If it remains small (illiquid) and largely accessed only by corporates then I’m not sure how it differs from the current Venture / Buyout markets. If it grows to become more liquid (through increased access) wouldn’t it just resemble the public market (and hence all the same regulation and issues that surround that?)As I was writing that sentence above it occurred to me that one potential area for this secondary market is the Corporate Venture you were talking about recently. That could be a good fit…

    1. fredwilson

      i don’t really like the idea of corporate/strategic investors acquiring stakes in privately held companies through purchases of founder stock. that’s what happened with eBay and Craigslist and you can see what the result is.my hope is we can get to a liquid and lightly regulated market of secondary purchasers who are qualified investors and thus we don’t need the heavy regulation of the existing public markets.

      1. Guest

        Fred,most companies have ROFRs with their founders. If the company has a problem with a corporate acquirer of stock, all they have to do is match the offer.I like your idea of a liquid market, it can be great for founders like myself who are well removed from employment in the company. I am just perplexed how employees can sell unregistered stock. The company has no obligation of disclosing material events; the employee, though, most likely has insider knowledge of how things are going in the company. It seems like an extremely asymmetrical information balance between buyer and seller.I appreciate the notion of qualified investors, but still, securities laws apply. The seller has to disclose material information on one hand, but he/she is likely under confidentiality agreement with the company on the other. Perhaps the buyer waives their rights under applicable laws, I guess…

        1. fredwilson

          It’s not a great outcome for the company to be using their cash,particularly if they don’t have a lot, to buy back founders stock justbecause it’s being bought by a corporate purchaser who is or may beunfriendly. Craigslist certainly didn’t have $25mm to buy the foundersshares that went to eBay.I think what we may need to do is change our stockholder agreements to putrestrictions in on selling to corporate purchasers

  3. kidmercury

    over the next few years, we are going to see the rise of many more secondary markets. IMO this is probably one of the most exciting things and is at the heart of the finance breakdown and revolution we are in the midst of.

  4. Ray

    Hmm, not so sure about all this. If the companies are on an upward trajectory, it all seems fine. But what if they’re not? Think about employees cashing out in 2000 from Pets.com and the others. Lawsuits would fly. Maybe it sounds like sour grapes, but as someone who labored 8 years without so much as a whisper about liquidity prior to the IPO in 1989, I have to ask ‘are the rewards so deserving, so soon?’ I also paid sizeable taxes on phantom gains that never materialized in the 90s — it’s not out of the realm of possibility that things can quickly turn upside-down in these scenarios.

  5. nikiscevak

    Just a quick fact check. The Microsoft part makes sense but there is also the consideration that they weren’t alone: There were the Samwer brothers and Li Ka-Shing who also participated at the same valuation with presumably the same rights (save for the marketing agreements).

  6. Shreshth

    I would be interested in buying some stock. neone selling?

  7. mcbreslin

    My professor at NYU in Entrepreneurial Finance – Alexander Ljungqvist – was doing research on that topic a while back. I checked and he is still there – you may want to reach [email protected]

  8. Chris Dodge

    Dare I ask, but how do you think such a “private secondary market” be regulated, if at all? In an above comment reply you refer to a “lightly regulated” market, but do you see a potential for deceptive practices and/or abuse?

  9. Michael F. Martin

    have said before that we need a more active secondary market for founder shares and shares purchased by early investors in venture backed companies.I completely agree. On the other hand, wouldn’t it be easier to just drop the SEC rules that make it so expensive to register? SOX has been a total failure at preventing fraud on investors — real estate bubble? financial bubble? hello? The only groups really benefited by SOX are the incumbent large corporations that have had less competition from new entrants.

  10. Darren Herman

    So who is building this upcoming secondary market platform (as it’s interesting to me) and I’d like to know why you do not like early shareholders semi-liquidating. You cite two examples, but would love to see the rationale behind them.

  11. andyswan

    Let me know if anyone will take the other side of my short-sell desires of facebook at 15b, 10b, 5b or 3b. :)lightly regulated, buyer/seller beware is the only way this would work and how the world SHOULD work…but I digress 🙂

    1. Guest

      I see nothing attractive in a world that rewards elaborate scammers. Markets that are based on trust and integrity are much more efficient and they require strict regulation and severe penalties for abusers.

      1. andyswan

        In my opinion, you are mixing the action and the tool. Of course, scamming people should be and is illegal, regardless of what tool you use to execute your plan (market, telephone, traveling salesmen…)I don’t see any reason for government to add friction to the tools of society and the economy.

    2. fredwilson

      I agree with you that buyer/seller beware is how this market should workBut with widows and orphans being prey to dishonest brokers, we need regulations in our capital marketsLook at the crap that went down with the auction rates. Sophisticated people got hosed

  12. jerome camblain

    A market where insiders face outsiders is by nature a difficult place to get a transparent price and a fair deal!In France people build funds to try to create an ersatz of liquidity.1- A promoter approaches 20 to 30 start-ups founders who will exchange part of their holdings in their company against shares of the new fund (I let you imagine the valuation issues, but it has been done once at least, the fund is called Agregator http://www.agregator.net/in…, & I have no personal involvement in that fund)2- Founders have diversified their holdings but are not yet liquid- at least their risk is mitigated.3- The fund get listed and investors can/will then exit in a later stage to realise some liquidity

    1. Guest

      Yes, there is such a fund in America, too. They approached me, in fact. The problem is I have witnessed so many mistakes by VCs, such irresponsible investing, I would be very leery of putting my stock in a fund like that. If they could guarantee that only companies funded by top quartile of VC funds are included in the fund, I would do it. However, 75% of VCs have negative returns, according to a study I saw. So not a very attractive proposition all in all…

  13. loupaglia

    I see the attraction of the secondary market, good point, but I question this much more from a standpoint of business fundamentals. And it simply may be that I don’t understand enough about it at this point. First, I think it is great that founders can benefit from a liquidity event, it is a reward for the risk. However, this strikes me close to creating massive “insider” risk.Can only certain employees sell on the private market? Only ex-employees? What stops an “insider” who knows something about what the company strategic about the firm or something that will certainly erode/de-grade the upside of the firm, so they sell their stock privately at the “height” of perceived valuation. And does the fact that these insiders are selling harm the market valuation for other shareholders similar to the way free markets question when a senior executive is unloading their holdings?

    1. fredwilson

      This has to be buyer beware. Just like the venture market

  14. Saul Lieberman

    On valuation:An investor should always be willing to pay a higher price if the cash goes into the company rather than the pocket of the selling shareholder.

  15. gregorylent

    these guys work at a company that has never made money, and they can cash out…

    1. fredwilson

      Facebook is worth a lot of money. Its not how much they make that drives value. Its how much they can make

  16. kenberger

    “The news […] naturally focuses on the price/valuation (a deep discount to the $15bn that Microsoft paid).”The article actually amuses me a lot, since it’s focusing on the thesis of foreboding amongst FB insiders rather than the much more huge story that a private company is making fairly pioneering efforts into (as you’re arguing) something very innovative and helpful to the industry.The author is using thinking as if FB were a public company– and it’s completely wrong. I think his focus is “natural” to the extent that joe schmoe wouldn’t realize any of this. And I guess he might not.It’s also telling that this kind of resulting press from the experiment happened, despite FB’s attempt to educate.

  17. kenberger

    http://www.saintsvc.com is an interesting SF firm I know that focuses on secondaries and has been for some time. Worth looking at for anyone interested in this sort of thing.