Can Private Stock Markets Save Silicon Valley?

The ongoing drought in financial exits is a huge drag on Silicon Valley. Even if entrepreneurs manage to build a company, they and their investors have a hard time getting any money out of it. Opportunities for going public currently range from rare to nonexistent. The other main route to financial liquidity, acquisition, is also not reliable enough to count on.

 Such conditions make it hard to build a company in the first place. Investors hesitate to fund it, and potential employees hesitate to leave more-secure jobs to take a chance on a startup. But some participants in a panel at the recent AlwaysOn & STVP Summit at Stanford argued that secondary markets provide an answer. Such markets in essence function as private stock markets as an alternative to public ones.

 Secondary markets allow companies to sell shares to investors without going through a public offering. That allows them to obtain cash to fund growth or to reward employees more quickly and effectively than they otherwise could. Such markets allow companies more control than they would have with public markets. They can limit the amount of information they provide investors, for example, though less information usually correlates with less liquidity. They can also limit how much of their shares employees can sell. Such markets can support both ongoing trading and one-off deals like the recent $200 million investment in Facebook by Digital Sky Technologies, which included an offer to purchase $100 million of Facebook common stock from existing shareholders.

 Institutional investors looking at long-term holdings are among the most likely potential investors for such markets, according to panelists. The big brokerage houses give institutions and other long-term investors short shrift in a couple of ways. First, they no longer provide the in-depth research necessary to make educated long-term investments. They also often don't provide the kinds of allocations at IPOs the institutions are looking for. The reason for the disinterest is clear: brokerages can make more money from high-volume short-term traders.

 In short, secondary markets can fill the attention, information and allocation gaps left by the disappearance of the old Wall Street system. They can also fill a size gap. These days IPOs often have to be in the billion-dollar range to have a chance of succeeding. Secondary markets can deal with much smaller companies of the kind that once could have gone public but no longer can. They can even fill a time gap. Panelist David Weild, founder of Capital Markets Advisory Partners, noted that the average time to IPO has stretched from 4.5 years in 1998 to 9.6 years in 2008, with the time to acquisition stretching from 3 years to 6.5 years in the same time. Secondary markets may thus provide liquidity significantly sooner than could other routes.

 Some VCs, of course, have noted that secondary markets have been tried in the past without making much impact. Barry Silbert, Founder & CEO of SecondMarket, claimed that this time is different. Secondary markets will become a standard part of the capital formation process, he predicted. He also expects cooperation and consolidation among various private marketplace efforts. Overall, he said, the process will level the playing field among VC funds, angel investors and secondary funds, which should lead to shakeout and disruption in the venture industry. If he's right, it will put VCs on the receiving end of the uncertainty and upset they're so good at instigating in the industries where they invest.

 Besides Weild and Silbert, panelists included Greg Brogger, founder & CEO of SharesPost and Mona DeFrawi, founder & CEO of InsideVenture.