go out and talk to clients on the buy side, and we found that there was demand.” In 2008, SecondMarket got about $20 million in such deals done. The company profits by taking a commission of up to 5 percent, split between buyer and seller. (See this excellent article by Bloomberg BusinessWeek writer Brad Stone for more background on the company.)
Thomas says that when SecondMarket researchers stepped back to try to understand the supply-and-demand equation for private company stock, they found a world that had changed drastically since the go-go 1990s, when the mean time between a startup’s first venture financing and its public offering was three to four years. It’s not just the economic downturn that has put a damper on IPOs. There have also been important structural changes in the public markets, from the decimalization of trading prices on the major exchanges (all but eliminating the bid-ask spreads that once made it so profitable for investment banks to sponsor public offerings) to the post-Enron Sarbanes-Oxley legislation, which made financial reporting more complicated and costly for public companies. “The net effect of all of these changes is that fewer companies are able to go public, and fewer want to go public,” says Thomas. “That is what motivated us to get into this market. There are literally thousands of venture-backed startups with no good alternative to provide liquidity to their shareholders besides an IPO, which can take a decade, or a sale.”
At the same time, there are plenty of buyers, from private individuals to big investment banks like Goldman Sachs and JPMorgan, who’d love to own shares in hot pre-IPO companies like Facebook and Twitter. At SecondMarket’s site, members can express an interest in buying or selling such shares, even if SecondMarket isn’t yet handling trades in the company’s stock. By gathering information in this way, says Thomas, “We were able to validate that for the top couple of dozen technology companies, there was an active market of buyers and sellers looking to transact. And even outside those top couple dozen, there’s a huge universe of companies where shareholders are looking for liquidity.” The 10 “most-watched” companies on SecondMarket in the second quarter of this year were Facebook, Twitter, Groupon, Zynga, Foursquare, Skype, Yelp, Dropbox, Gilt Groupe, and LivingSocial.
In the second quarter of this year, the company handled $112 million in private company stock trades. That was a drop compared to the $156 million in trades in the first quarter, thanks largely to SecondMarket’s move toward courting issuers rather than shareholders. But it’s still a big increase over the $51 million figure for the same quarter a year ago.
A Question of Control
Silicon Valley CEOs say privately that the emergence of secondary markets for employee shares is a growing and largely unwelcome distraction. Companies like Facebook and Groupon have taken some of the pressure off by arranging for outside investors to buy common stock from employees. In a deal sanctioned by Facebook, Digital Sky Technologies (DST), founded by Russian investor Yuri Milner, snapped up $100 million in employee shares in 2009. Groupon did something similar—a good portion of the $135 million it raised in 2010 from DST and Battery Ventures went straight into the pockets of founders, employees, and early investors. But not every company has one or two deep-pocketed backers willing to provide all the liquidity employees want.
David Sacks, the founder and CEO of three-year-old enterprise social networking startup Yammer and the former COO of PayPal, is one of the few Silicon Valley executives who will speak on the record about the issue of pre-IPO liquidity for employees. “I think there are circumstances under which it does make sense to let employees cash out,” Sacks says. “One instance where it make a lot of sense is when you have a choice between going for the home run, the IPO, or taking an acquisition offer. The VCs always want to go for the home run, but the employees tend to be more conservative because they have all their eggs in one basket. So allowing a partial cash-out is a mechanism to align incentives.”
But even in these cases, finding a single outside investor like DST is a better solution than letting employees trade at will, Sacks says. “Our view is that we want would to keep control over that process,” he says. “A company has to be very careful about
