Randy Hawks: The Argument for the Secondary Market

There has been a lot of buzz around highflying companies allowing sales of their stock on secondary trading platforms. There have always been opportunities for individual secondary sales in private companies but nothing to match the current level of action. Before, occasional private party sales were allowed by company boards for purposes such as individuals buying a new house and funding education. Now we see wholesale transactions by many individuals – but generally only in the hottest companies.

With the IPO window so narrow, many successful companies find limited opportunities for liquidity. Some companies, such as Facebook, choose to stay private and avoid additional burdens of being a public company. Still, they want to motivate employees by allowing secondary transactions to reward their contributions. SharesPost and SecondMarket created dueling online marketplaces to enable this kind of trading, allowing employees to participate in some level of liquidity while the company remains private. Utilizing this marketplace removes some pressure from company management and allows consideration of corporate growth capital from other sources. It also provides a small economic boost in that employees that might otherwise be tethered to organizations years away from an IPO exit are instead provided with the capital they seek in an immediate timeframe. To date, the volume of these transactions remains tiny compared to the broader public markets.

This evolving activity does come with some potential for negative effects. Financial transparency can be lacking. Individual purchasers of shares may be driven solely by buzz and hype. Block purchases by institutions can be directed by inside investors, avoiding a true “open market.” Accreditation standards for the individual investor are loose enough to allow folks ill-equipped for private company trading to engage. In addition to these issues, it is still unclear how the SEC will view the “over 500 shareholder” status of companies who inadvertently pass this threshold, creating a de facto “public” company.

I expect the SEC will weigh in – although a day late – with clarifications. Requirements for financial disclosure, investor qualification and level playing field transactions need to be defined. On balance, the benefits of a lightly regulated private exchange of shares can enhance the entrepreneurial economy, creating an alternative for private company employees to share in some of their companies’ financial success. Seems to me we are seeing the early stages of a new – and good – thing.

Randy Hawks is a Managing Director at Claremont Creek Ventures, investing in Information Technology security investments. His investments include Billeo, Sentilla, Shotspotter and WiredBenefits; he blogs here.