Private Placement Stock Exchanges

Trading in shares of still-private Silicon Valley companies such as Facebook Inc., Twitter Inc. and LinkedIn Corp. has surged in recent months, suggesting strong investor interest in some technology start-ups despite a moribund market for initial public offerings.

Though the firms remain private, they have shares, and some employees or investors who have received such stock want to cash out. Others want in. The sellers and buyers can be matched through private deals or by exchanges that have sprung up to bring them together.

And inside some private companies about abiding by regulations and keeping market expectations in check.

Trading in shares of Facebook has been particularly strong in the past month. The surge began after a big transaction in November, when venture-capital firm Accel Partners, an early backer of the social-networking firm, sold less than 15% of its stake for $517 million, say people familiar with the deal. The deal, some details of which were reported on tech blogs, valued Facebook at around $35 billion, those people say.

Soon after the sale, Facebook’s trading volume and price surged on SharesPost and SecondMarket, two exchanges that allow trading of closely held firms’ shares. In the past month, the average valuation of Facebook based on transactions on SharesPost has risen almost 25%, to more than $56 billion, the exchange said. SecondMarket said Facebook’s valuation had risen about 12% over the same month. Such differences are possible because these aren’t public markets.

Facebook trading is the most visible part of a growing market for shares of private tech companies. SecondMarket and SharesPost, based in New York and the Los Angeles area, respectively, began offering trading of private-company stock in the first half of 2009.

SecondMarket said it has transacted nearly $400 million in private-company stock this year, up from about $100 million last year. SharesPost declined to cite dollar figures but said it did 50 private-company stock transactions in its first six months of operation and 150 in the 12 months since.

These are still relatively tiny numbers compared with the trading in tech companies that have gone public. The exchanges remain far smaller than public exchanges like the New York Stock Exchange and Nasdaq.

Private exchanges differ in that they take shares from sellers or companies and actively find buyers, a process that can take several weeks. Recently, SecondMarket and SharesPost have been offering auctions of private-company stock to simplify the matching process.

Before the emergence of such exchanges, founders or employees of start-ups had fewer options for selling before a public offering. They typically sold shares to investors via opaque deals arranged by brokers, known as private placements.

The lackluster IPO market, along with the hassles of being a public company, have meant that some start-ups are staying private longer, creating a backlog of potential sellers. This, in turn, has lured institutional investors hoping to acquire chunks of promising start-ups. The Internet companies Facebook, Twitter, Linked In and Zynga Inc. are among the most sought-after, say investors and the private-company exchanges.

Facebook Chief Executive Mark Zuckerberg has said he is in no hurry to go public. In September, early Facebook investor Peter Thiel told Fox Business News the company wouldn’t trade publicly until 2012.
The value of transactions in private-company shares has more than doubled in 2010 to $4.9 billion, from $2.4 billion last year, according to NYPPEX, a research firm and broker-dealer. Facebook has accounted for 48% of private-company transactions on SecondMarket this year and 40% of those on SharesPost, the exchanges say.

As trading increases, some companies are taking steps to monitor or curtail it. Unrestricted trading could lead them to bump up against Securities and Exchange Commission rules that limit the number of owners on a closely held company to 500. Beyond that, a company must disclose more financial data.

Facebook has taken several steps to curtail the private trading. In 2007, it stopped issuing stock options or shares to new employees, instead giving them restricted units that won’t become stock until Facebook goes public.

Nevertheless, trading of Facebook shares in the private markets is vigorous. On Dec. 17, SharesPost completed an auction for 165,000 Facebook shares, which the exchange said was heavily oversubscribed.

Facebook has tried in the past to help employees who want to take some money off the table. Last year it arranged a program for employees to sell at least $100 million of shares to Russian investment firm Digital Sky Technologies, which also invested $200 million directly in Facebook.

In April, Facebook forbade employees who hold shares to cash out to other investors. The move was designed “to better comply with insider trading laws and to protect the interests of the company and its employees and shareholders,” a Facebook spokesman said. But the company can’t stop former employees, early advisers or private investors who own shares from selling them.

Like many other tech companies, Facebook holds the right of first refusal over any potential transaction on the secondary market. It has the option to either buy the stock itself or find another buyer within 30 days who is willing to pay the same price.

Attempts to skirt Facebook’s right of first refusal can cause prices to rise. David Williams, a start-up investor at 2020 Ventures LLC, said he started buying Facebook shares in the past year on SecondMarket and SharesPost.

Earlier this year, to get past the right of first refusal, he said he hit the highest price asked for a batch of Facebook shares on one of the exchanges—$72, even though the shares were generally going for $60 to $65 then.

Mr. Williams said he bet that, at the $72 price, Facebook wouldn’t buy the shares back. The tactic appeared to work: Mr. Williams ended up buying the shares. Facebook has since done a five-to-one stock split. Mr. Williams has accumulated about 50,000 post-split shares.

Such dynamics have alarmed some investors, since many people buying private-company stock have no insight into those start-ups’ financial performance. John O’Farrell, a partner at venture firm Andreessen Horowitz, which confirmed buying Facebook shares last month, said people now “will almost literally buy at any price” into companies like Facebook.

“As a private company, we don’t typically share information about our financial performance,” said the Facebook spokesman. “While there are external attempts to forecast our revenue or value the company, many of them involve a great deal of speculation.”

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