In another sign that the secondary market for private company stock is going strong, Elevation Partners will soon complete its third large transaction in the past year. This time, Elevation will buy $100 million of Pandora stock. In June 2010, Elevation purchased five million shares of Facebook common stock for $120 million. Back in November 2009, the private equity firm acquired 2.5 million shares of Facebook preferred shares for $90 million. During the second quarter of 2010, over $50 million in private company secondary market transactions were completed through the Second Market trading platform.
These deals raise the question: Why is the secondary market for private company stock getting strong now?
Reasons Why The Secondary Market For Private Company Stock Is Surging
The secondary market for private company stock has became a viable trading platform. Several factors in combination have produced the conditions for this market to flourish:
- The weak market for IPOs since at least 2007
- A low number of mergers and acquisitions during 2009 of any year this decade
- More companies hesitating to go public because of corporate governance concerns
- More companies want to stay private longer to maintain control over their strategic direction
Benefits To Venture Capitalists
These factors have created a liquidity problem for earlier stage investors such as venture capitalists. Venture capitalists have typically had their money in the companies for many years. However, VCs need to be able to exit their investments in order to provide a return to the limited partners. When VCs sell their stakes in the secondary market, they are able to give capital back to the limited partners. During this difficult fundraising environment, VCs want to do all they can to return capital to the limited partners sooner rather than later. Weak VC returns during this decade add a sense of urgency to this imperative.
Benefits To Private Companies
Most companies who stock is traded on the secondary market are late stage venture capital backed companies. With the infusion of capital that accompany these transactions, the companies are able to stay private longer.
Further, purchases on the secondary market give companies a way to let their employees cash out on their other illiquid shares. In 2009, Facebook did a variation on this theme by buying back employee common stock. Employees are happy because they do not have to wait for an IPO or acquisition to benefit from their equity stake.
Discussion
Entrepreneurs won’t start companies and investors won’t invest in them if there is no path to liquidity on the company stock. A secondary market for private company stock can fill the gap that the lack of an I.P.O. market has created.
While this market for private company stock provides benefits to the company and to VCs, these transactions involve securities law and business strategy issues. I will continue to discuss these legal and business issues surrounding the secondary market. Whether you are on the buy side or the sell side, consult your business and legal advisor before engaging in such transactions.
If you have experience with these transactions, please share your story by leaving a comment.
Twitter: @DougYPark
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