The Secondary Market Universe is Expanding!

The secondary market is expanding at a blinding pace. SecondMarket recently revealed plans to substantially increase its offerings of pre-IPO company stock to about 12,000. SharesPost, which said it will follow in SecondMarket’s footsteps and seek to become a registered broker-dealer under FINRA, is likely not too far behind.

Already, secondary market trading has provided a valuation boost for many VCs’ assets, including Facebook, Twitter and Zynga. Now, the kudzu-like expansion of startups’ inclusion in the market will generate more short-term profit and loftier expectations for investors, many of which have no affiliation to venture capital or to VC LPs. This comes as the S.E.C. conducts an inquiry into the secretive marketplaces and as prominent politicians from both sides of the aisle seek more information on them as well.

The short-term boom that will follow for many VCs’ portfolio companies is accompanied by the potential for a bust when these shares debut on public markets and are subject to global market volatility. Several sources acknowledge that, in the last few weeks, while American equities markets have fluctuated wildly in the face of international crisis and disaster, secondary markets valuations have hardly been ruffled at all.

Perhaps Twitter’s business model is less exposed to the ongoing Libyan conflict or the effects of radiation leaking off Japan’s coast than other companies. Still, if and when it goes public, Biz Stone can’t possibly view a two percent whipsawing of the Nasdaq in one session as a neutral event for his company. In the last two weeks, Apple shares have fallen, while the price of Facebook stock on Sharespost appears to have risen about three percent, from $33 each to $34 apiece—but how many investors would readily concede the tech giant is less capable of weathering a market downturn compared to the social network?

By the time many of the companies found on secondary markets are part of the broader, listed equities spectrum, their valuations—in some cases inflated by more than a year of “significantly oversubscribed” bidding—may appear ripe for shorting.

Of course, by then, VCs will have long exited their shares, or at least a hefty portion of them. But the development of, and possible popping by, two massive VC-backed bubbles in the span of about 15 years will tarnish the industry’s reputation, especially with retail investors, most of whom still feel the burn of Fall 2008.

VCs’ mantra that “this time is different” is only appealing now, as secondary markets and private companies’ shares are given a lift by a fast-rising tide. Clearly, it is enough to drive envious investors to secondary markets. The bubble that popped at the turn of the millennium was fueled by wild speculation and optimism over companies that went public before they could prove a business model would even be successful. This time, since VCs cannot take unproven companies public with the same ease they had a little over a decade ago, they are being pumped up on private exchanges.

As the secondary market universe continues to expand, one can’t help but channel little Alvy Singer: right now, this universe is, in fact, everything to VCs. Their assets are, one by one, and at an increasing pace, gaining validation and value through the expansion of the secondary trading platform. However, as this universe—and this bubble—expands, its potential to break apart only grows.