Aside from the film “The Social Network,” the most important starring role for seven-year-old Facebook in 2011 may well be in the secondary market, a key factor in the company’s $50 billion valuation after recently raising a total of $1.5 billion in capital.
Like other ascendant tech players including Twitter, Groupon and Zynga, Facebook has opted to remain private for now. Although technically still start-ups in the post-VC, post-angel-investor funding phase, trading activity in private company shares accelerated by 400 percent on SecondMarket in 2010. (SecondMarket has now surpassed a half-billion dollars in completed transactions since the launch of its private company market in April 2009.) This level of activity is in stark contrast to the tepid reception that the limited number of IPOs had received during the past two years of economic and regulatory upheaval.
A strategy to staying private
The red-hot private shares market is proving especially appealing to entrepreneurial owners, past and present employees, and antsy venture capitalists — all of whom generally want to cash out, as well as investors seeking ground-floor pricing. Throughout the investment world, there is growing awareness that trading private shares can do more than that. The secondary market increasingly represents a strategic tool.
“Young technology companies are growing faster today than before, in part because of the Internet, and can scale up more quickly,” explains Alexander Tamas, the Digital Sky Technologies Partner who led recent private investments rounds in Facebook, Zynga and Groupon.
“In a hyper-growth situation, the fewer restrictions the better. You can make strategic decisions for which the near-term ROI is not necessarily visible and which the public may not appreciate,” he says. “Public market investors are smart, but not necessarily patient. So, staying private during extremely fast growth makes sense for many companies. Once the company is more stable, it becomes easier to navigate in the public spotlight.”
The downside to staying private? Secondary trading can become a double-edged sword at the 500-shareholder mark, which triggers Sarbanes-Oxley reporting requirements similar to those that apply to publicly traded companies. In addition to the added work of filing its financials with the U.S. Securities and Exchange Commission (SEC), such a move toward public disclosure may disadvantage a young company by exposing its cost and margin structure to competitors.
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