February 28, 2024

DealBook Column: SecondMarket, an Exchange Lacking Volatility — Sorkin

Barry Silbert, chief executive of SecondMarket.Francis Specker/Bloomberg NewsBarry Silbert, chief executive of SecondMarket.

“The public markets have really become like a casino.”

That’s how Barry Silbert, the chief executive of SecondMarket, the fast-growing private stock exchange for start-ups, views trading on the big exchanges like the New York Stock Exchange and Nasdaq.

If you don’t know SecondMarket, you should: Whenever you hear about companies like Facebook being valued at as much as $100 billion or Groupon at $15 billion — before they’ve had an initial public offering — the sky-high values are in large part being set on exchanges like SecondMarket, which allow wealthy investors to trade shares of private companies in the secondary market. Think of it as an eBay for shares of private companies.

Of course, some people might consider that a casino.

But they would be wrong. Mr. Silbert’s company is trying to rewrite the rules of investing by finally creating an exchange for investors, not just traders.

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And on Tuesday, Mr. Silbert is taking an unusual step: He is listing his own company’s private shares on SecondMarket.

Over the last several weeks, he secretly ran a private electronic auction on SecondMarket for a slice of the company. A handful of the most influential investors in the start-up world have taken stakes in SecondMarket, including the Facebook-backed fund, the Social + Capital Partnership; Yuri Milner, the Russian investor with stakes in Facebook, Twitter, Groupon and Zynga; and Ashton Kutcher’s investment vehicle A Grade Investments. (Yes, that Ashton Kutcher.) In total, SecondMarket raised $13 million at a valuation of $160 million.

While that may seem like small potatoes compared with NYSE Euronext — which has a valuation of $6.5 billion — the story of SecondMarket is worth considering against the backdrop of what seems like out-of-control volatility in the public stock market and an anemic market for I.P.O.’s.

Mr. Silbert, who looks even younger than his 35 years, set out in 2004 to create a market for secondary shares, allowing private companies that are often too small to go public to have their employees and investors sell their shares on an exchange.

His exchange allows for certain rules that the public market does not: a company selling shares on SecondMarket can choose which investors are allowed to buy — weeding out fast-buck artists — and how frequently they can trade those shares. If a company wants to allow investors to trade their shares only twice a year on specific dates, that’s fine.

The benefits are obvious: employees and investors can cash out some of their stakes without having to go through the formal and rigorous process of an initial public offering. That, in turn, can allow traditionally cash-poor pre-I.P.O. employees, for example, to afford to stay at an emerging company that might not be ready to pursue an I.P.O. until it matures some more.

It also creates a real market, with real values — “price discovery” in Wall Street parlance — for pre-I.P.O. companies as opposed to the made-up valuations that venture capital firms often put on companies in successive series’ of financing.

The drawbacks are also obvious: Employees and investors who sell shares early may not be as aligned with the company. And the private market does not come with all the disclosures that a public offering would, making it rife for abuse if not properly monitored. The Securities and Exchange Commission has been studying this emerging industry in recent months.

In truth, Mr. Silbert’s company probably should not exist. Its success is a function of a series of rules and regulatory changes over the last decade that has upended the public stock market for start-ups. (His company competes with a smaller rival, SharesPost.)

Just consider this: “Back in the ’80s and ’90s, there was 400 to 500 I.P.O.’s happening a year,” Mr. Silbert said. “If you look over the past decade, a good year is 150 I.P.O.’s and bad year, like it was last year and the year before, is well below 100. That is kind of scary.”

And here’s another scary series of numbers: The average time it took in the 1980s and 1990s for a company to go public from when it was founded was four to five years. Today it is 10 years.

Of course, some companies, especially in the late 1990s, may have gone public too quickly or should have never gone public at all.

But taken together, the statistics demonstrate that it is much more challenging to gain access to the public capital markets — and may ultimately make it harder for entrepreneurs to start and grow small businesses.

“The I.P.O. market really dying a slow death,” Mr. Silbert said, hardly happy about it.

To hear Mr. Silbert tell it, the death of the I.P.O. market has its roots in the end of research from investment banks and the move to online trading brokers like E*Trade.

“Back in the day, you would have literally hundreds of thousands of brokers making calls every single day pushing what were typically smaller-cap stocks,” he said. “That ended when you shifted to online brokers.”

Those brokers used research, which has now dried up, to back up their sales calls. (Again, there is a flip side to this argument: some of that “research” was conflicted and there were also boiler-room style brokerage shops that abused unsuspecting investors.)

Now, start-ups can monetize at least part of their business. SecondMarket, for example, has been a boon to Facebook because many of its early employees have been able to cash out some of their shares.

Mark Zuckerberg, the founder of Facebook, has donated $100 million to the Newark schools, a prospect that would have been more difficult without a robust market for the company’s shares in the secondary market.

As part of SecondMarket’s offering, employees were allowed to cash out up to 30 percent of their shares through the exchange.

Mr. Silbert was the largest seller. He demurred to say exactly how much money he “took off the table” except to say it represented only 10 percent of his holdings of the company.

So how did Mr. Silbert feel about, as he said, “eating his own cooking?”

“We weren’t like ringing the bell at the exchange, but everybody would gather around the computer screen waiting for what is going to be the best price, highest price,” he said. “That was pretty exciting.”

Article source: http://feeds.nytimes.com/click.phdo?i=9e7dbc69aa11300ded1720eaf0ac635d

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