Dearth of liquidity for private company shares, it’s the IR stupid!

Private company shares were being ‘traded’ since the dawn of their existence, however thanks to Secondmarket, Sharepost and Facebook, trading private shares became a buzz word in the tech and financial communities. for a moment, a new era seemed at hand where the difference between the public and private markets would be irrelevant. The private secondary markets seemed unstoppable in their growth of participants and liquidity.

However, behind the headlines, the transformation of private markets proved short-lived and mainly driven by hype. Facebook stock made up almost half of the total turnover on these markets, followed by other hot consumer web companies such as Zynga and LinkedIn. Those last two went public in 2011, and were followed by the hotly anticipated Facebook IPO in May 2012. Since then, people have been wondering What’s next for private markets?.

With hindsight, it seems clear that private company stock achieved huge trading volumes in 2011 mainly because buyers were willing to pay anything to get their hands on hot consumer web stocks, hoping to benefit from a company’s inevitable IPO. And even in those days, the private markets did not resemble the public markets in liquidity or volume. When you buy shares on the private markets, you cannot resell them the next day, unless you want to face the risk of of breaching securities regulations.

More importantly, the red hot private company market of 2011 failed to benefit the majority of holders of private company shares. It was a typical case of a few participants (brokers from their commissions and holders of stock of a handful of companies from increased liquidity) benefiting enormously from what was a relatively small segment of the total market. Why did the market failed to expand? I believe is was because of a lack of IR coming from private companies. The few consumer web companies that did achieve a semblance of liquidity did so because they were hugely popular household names and buyers did not require any company information to be disclosed. This ended in nothing but disappointment. Bear in mind also that buyers of FB stock pre-ipo paid a 3% fee to either Secondmarket, Sharepost or another brokers, and also likely incurred additional legal fees during the transaction. They could have bought the same shares, (actually not the same ones, pre-IPO they bought ‘restricted securities’ that they have to hold until the window for selling for insiders opens) through a click of their mouse and by paying 0.15% in fees with no additional legal costs.

The private company market of 2011 is not a sustainable model that will bring liquidity to the masses of common shareholders of private companies. In the past, private shares would trade through occasional transactions between parties with pre-existing relationships, and with the participation of the private company involved. Buyers had to work hard in earning the trust of management and become long term shareholders. Information would be provided to would be buyers, and usually no broker was involved. These were old fashioned deals between people with an established business relationship. (read my other blog post on the history of private markets for more info)

I believe these ‘old fashioned’ deals are the way forward. Private shares are an illiquid and difficult to value asset class with a lot of regulatory baggage, and are best left to be purchased by experienced accredited investors or dedicated funds.

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