As Startups Ponder The Secondary Market, More Seem To Make Private Info Public

The secondary markets for private company stock may seem like the Wild West, with unstructured valuations and less than ideal information disclosure.

Yet several securities laws apply to transactions now taking place, and the onus falls on companies to follow rules meant to level the playing field, including making some confidential information about their businesses public.

This was the key takeaway of a National Venture Capital Association Webcast discussing the recent phenomenon of secondary market trading. The bottom line is this: startups interested in permitting their shares to trade on a platform such as Second Market or SharesPost need to take steps to protect themselves from potential lawsuits.

“I think companies are saying, ‘I do want some information out there so there won’t be disparities of information,’” says Francis Currie, a partner at the law firm of Davis Polk & Wardwell.

They realize a lot of the selling and buying involves insiders who have the information, Currie said on the Webcast. And they fear a sharp fall in the stock price could lead uninformed outsiders who purchased shares to file a lawsuit.

According to Currie, the information most appropriate for disclosure includes a list of material risks facing a company’s business and recent financials, but not projections. The Securities and Exchange Commission hasn’t yet weighed in on the topic, but it is examining issues associated with secondary market trading, particularly the 500 shareholder threshold that forces private companies to disclose financials and other data. So more clarity could come from the SEC over time.

As it stands, though, company insiders such as directors and officers need to take certain steps when they trade, says Currie. This includes making sure buyers are sophisticated and have sufficient access to information.

Information access was a key consideration when privately held Pandora Media Inc. developed a tender offer to let employees sell shares, says Delida Costin, general counsel.

Employees who had been with the 10-year-old company for some time were eager to find some liquidity, and it was “starting to distract us” from executing, Costin said on the Webcast.

The company’s plan let employees sell some of their holdings to existing investors and primarily board members. A price was set and the window was opened for about 30 days.

Then employees were given access to the same information about the company that directors had so they could make informed decisions, she said.

“We were able to move on and the distraction level plummeted,” Costin said.

Pandora has filed to go public but has not yet priced its shares. Despite the company’s efforts to level the playing field, it will be interesting to see how employees react when it does.

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