February 6, 2012 8:04 pm

Facebook to be keenly missed by private markets

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Private secondary markets, whose businesses were built around trades of Facebook shares, will face a sharp drop in trading volume once the social network goes public, calling into question the long-term viability of the marketplaces.

Facebook’s exit from the secondary markets will make it easier for other start-up companies, like Twitter and Dropbox, to stand out, but analysts believe investor interest will still fall far short of the obsession with the social network, which dominates trading on the markets, accounting for around two-thirds of transactions on SecondMarket.

“There is no question that the void of Facebook will be felt dramatically in the secondary markets’ business; hugely,” said Manuel Henriquez, chief executive of Hercules Technology Growth Capital, which has bought Facebook stock on the private market. “There is no other juggernaut of that size out there.”

Secondary marketplaces allow investors to trade common stock of private companies, giving ex-employees a way to cash-in their stock before a company’s initial public offering.

Industry insiders in Silicon Valley have welcomed the markets as an important stepping stone for companies that are not yet ready for Wall Street, as they allow start-ups more time to grow and avoid the pressure of selling to an acquirer, while providing greater opportunities for investors as the number of IPOs has shrunk in recent years.

SharesPost and SecondMarket are the two main companies facilitating these trades and since trading began in 2009, volumes have increased sharply. SharesPost said its average transaction size grew from $100,000 in 2010 to $1m in 2011, while SecondMarket’s total trading volume increased from $360m in 2010 to $558m in 2011, according to its annual report.

In large part, these marketplaces were created for Facebook, in response to the needs of early employees who wanted to liquidate their stock and could not wait until the company decided to go public.

“They were the pioneers – probably unwilling pioneers,” said Greg Brogger, founder and president of SharesPost. “They were forced to blaze a trail.”

Facebook had to wrestle with many issues associated with the new marketplace, from insider-trading concerns, to disclosure of information about its business, to controlling shareholder numbers, given the 500 maximum number for unlisted companies.

Almost three-quarters of buyers on the private secondary market are institutional buyers, like mutual funds and hedge funds. The trades are considered risky because companies whose shares are traded are not required to disclose details about their business as they are when traded on the public market, and some market participants say that has lead to overheated valuations. But investors see an opportunity to get a discount on stock in pre-IPO companies and reap profits that otherwise go to public-market investors.

Bankers could use the secondary markets as a reference for setting Facebook’s share price on the public market, as LinkedIn’s bankers did. In the last two weeks, Facebook’s private share price has risen from $34.50 to $40 on SharesPost.

Facebook’s departure from the private market “will be the end of an era,” Mr Brogger said, but both he and Jeff Thomas, senior vice president at SecondMarket, believe another generation of start-ups will take Facebook’s place.

“Facebook has validated the model,” Mr Thomas said. “Now we’re targeting the next 200 great companies out there.”

He said he goes out every day to visit Silicon Valley companies to pitch them on the value of the private secondary market. He believes investor interest will shift to other social media companies, as well as enterprise software companies and data analysis companies.

On SharesPost and SecondMarket, Twitter is the second most traded company after Facebook, but a distant second, said Joe Grundfest, a former commissioner for the Securities and Exchange Commission and professor at Stanford Law School.

Bloom Energy, a green energy company, Gilt Groupe, an online luxury sale site, Dropbox, a file sharing service, and Yelp, the popular online review site that filed for its IPO in November, are listed after Facebook and Twitter as high volume stocks on both sites. Square, LivingSocial, and Spotify are also on SecondMarket’s most-watched list.

But Mr Grundfest said it was unlikely that investors would flock to these companies the way they did to Facebook. These companies have fewer employees looking to sell, and investor faith in Facebook’s growth and promise ahead of its IPO has been unparalleled. These factors could harm companies like SharesPost and SecondMarket.

“I don’t know that I’ll say they will go out of business,” he said. “But they’ll certainly face growth challenges.”

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