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financial regulations

What are the financial regulations that a start-up needs to take into account when issuing equity based compensation, whether stock options or RSUs?

It turns out there are quite a few. I will discuss one, which allows private companies to issue securities to their employees without registering the offer with the SEC.

A general rule in US financial regulations is that one cannot issue or sell securities without first registering them with the SEC, unless an exemption applies. We have looked at this before in the context of selling private shares.

The first way to avoid registering securities issued as compensation is by ensuring that the employee who receives the grant is an accredited investor, a director or an executive officer. So that covers your most senior employees. What about everyone else?

The other way to avoid registration is by ensuring that the issuance is ‘non-public’. (remember the section 4 (1 1/2) exemption for selling private shares?). However, determining what a ‘non-public’ offering is can be very difficult. It involves assessing the financial sophistication of the employee and providing information typically found in private placement offerings.

In order to help out, the legislator came up with something called Rule 701 of the Securities Act of 1933.

How to sell up to $1M in stock compensation?

Rule 701 makes is possible for private companies to sell up to $1M in ‘securities’ to their employees as part of a compensation plan (and more than $1M under certain calculations that I am leaving out here). There are some simple requirement such as that the issuance must be made under a ‘written’ plan. This basically means that you must have a contract or other piece of paper which sets out the terms of the plan. So far so good.

How to sell more than $5M in stock compensation, and how not to do it?

If you are a rather large private company and want to issue more than $5M in securities to your employees, things get a little more complicated. In that case, you will need to make certain detailed disclosure to your employees, including financial results. I am not going to go into the details of those disclosure requirements, but let’s say that if you feel that this is too much for your taste, you are not the first. Google chose to ignore those requirements back when it was private, because it ‘viewed the public disclosure of its detailed financial information as strategically disadvantageous’. This became a problem when the company went public and the SEC started looking more closely at the company’s compliance history.

This resulted in a SEC’s cease and desist order in 2005, which also provides a detailed account of Google’s compliance policies and failures.

Google’s path to an IPO, and the $80m in securities issued in the meantime

In it’s first years of existence, Google coud easily rely on Rule 701 as it’s stock option issuance did not reach levels requiring detailed disclosure to recipients. This changed in late 2002, when the company first became aware that it soon would reach such levels as would mandate additional disclosure to employees. The company temporarily stopped issuing stock options because it ‘viewed the public disclosure of its detailed financial information as strategically disadvantageous, and the company was concerned that providing option recipients with the financial disclosures required by Rule 701 could result in the disclosure of this information to the public at large and, significantly, to Google’s competitors‘.

In early 2003 the company wanted to resume issuing stock options. The general counsel, David C. Drummond, came to the conclusion that Google could avoid the additional disclosure that would come from issuing more options by not relying on Rule 701 but instead on more esoteric exemptions(yes the ones mentioned above who are notoriously complicated). If this turned out to be wrong, the company could simply repurchase the issued options under a ‘rescission offer’ as per Mr. Drummond.

Google started issuing stock option again, ultimately resulting in about $80M worth of securities being issued to employees and consultants without registering the offering and without providing financial information required to be disclosed under the federal securities laws. For clarity, when issuing securities you either have to register them(basically go public) or rely on an exemption from doing so(which would be Rule 701 or one of the more esoteric exemptions in this case).

As it turned out, the SEC came to the conclusion that those esoteric exemptions were not available to Google, and that the rescission offer the company made in 2004 did not cure any prior violation of securities law. The company had essentially been issuing about $80m worth of stock illegally.

The lesson seems to be that larger private companies who wish to issue any form of equity based compensation (RSU, options and others) in excess of $5m should meet the disclosure requirements of Rule 701. The majority of your employees are not going to qualify as accredited investors, and attempting to avoid 701 by relying on esoteric private placement exemptions is only going to make your life more difficult and is unlikely to result in a successful exemption.

SecondMarket recently came out with info on their 1H 2012 activities, which I think are telling about the state of the private secondary markets.

“We’ve never had so many companies engaging with us,” Barry Silbert, SecondMarket’s CEO, told CNBC Monday. “They’re looking at what’s happening in the public market with the way stocks [from recent IPOs] are getting pummeled, [and] the way that the management teams getting destroyed in the press,” and want nothing to do with it, he said. CNBC further adds that ‘Silbert wants SecondMarket to be the solution for small companies wary of those IPO pitfalls to get liquidity’.

This is a very interesting view from someone on the inside of the private secondary markets. In the case of Facebook, it is probably correct to say that the stock is getting  pummeled in the public stock market, and Zynga is certainly facing <a href=’http://www.bloomberg.com/news/2012-08-22/zynga-spurning-sale-strands-owners-at-worst-web-value.html&#8217; target=’blank’>several difficulties</a> in the public markets. But can we really say this amounts to an ‘IPO pitfall’ for private companies going public?

The public markets seem to be treating the average tech IPOs well. Witness the recent IPO of Kayak and Palo Alto Networks. Both companies had great public debuts. The WSJ quoted Palo Alto Chief Executive Mark McLaughlin that Investors appear eager to buy IPOs “if you have a strong company”, who further said that “Not surprisingly, a lot of institutional buyers will take a long view on a good company. They’re not worried about what the market was doing yesterday or how it performed today”.

The FT recently stated that ‘Facebook shares have fallen despite the success of other technology public offerings this year. The other 22 IPOs from the sector in 2012 have an average gain of 25 per cent through to the end of last week, according to S&P Capital IQ, a research firm.’

Perhaps Facebook getting pummeled in the public stock market is a reflection of a disappointing current monetization strategy from the company. The price of a stock should reflects the expected future earnings. Public investors are disappointed by the current revenues of the company and therefore expect future earnings to be disappointing as well. If you disagree and think Facebook is being undervalued by the market, you can buy the stock. At least you can do so now with full knowledge of the company’s financial position.

Facebook enjoyed very high valuation on private secondary platform such as Secondmarket, and perhaps the fact that it didn’t report its results to buyers in those markets played a role. As the NYT noted as early as 2010:

“Investors are taking on substantial risk when buying shares in these private companies. Despite Facebook’s ubiquity it does not disclose its financial results.”

One such pre-IPO buyer candidly admitted to the WSJ that he thought it was a “bragging right” when he landed the opportunity to buy (Facebook) shares last fall at $31. “I accepted the fact that this was a speculative play,” he said. “But I thought the pre-IPO price was just bound to be lower than what it would be on the public market.”

Felix Salmon provides on his blog an interesting view into the 2011 frenzy to acquire private shares of Facebook: ‘it’s increasingly looking as though shares in private tech-companies are a bit like fine art prices: a place for the rich to spend lots of money and feel great about owning something very few other people can have. The minute they become public and democratic, they lose their cachet. And a lot of their value.’

So what can we deduct from all this? What is the difference between the private and public secondary markets?

The main difference between the private and public stock markets is that public companies are subject to disclosure requirements while private companies are not, and that trading in the public market is cheap and liquidity is usually plentiful, while it is lacking and expensive to access in the private markets.

If you buy stock of Facebook today, you can do so for  $10 or less in transaction cost, and you can sell it back to the market any time. If you bought shares of Facebook in the private markets, you paid 2 to 5% in commission, and you can sell your shares at the earliest on August 16 2012, when the first batch of insider lock-ups expire. Reselling private shares within the private markets themselves is almost no-go, because of legal restrictions

Before the 2011 ‘private market frenzy’, savvy professional participants in the private markets would usually build a relationship with the company before buying shares, and get access to company information. John Glynn of Glynn Capital Management, recalled in a Business Week article that “These were very occasional transactions, and it was done the old-fashioned way. You earned the respect and trust of the company, and they ended up wanting you as a shareholder.”

The key lesson would be that you should only buy private shares from a company with whom you have an established relationships and who grants you access to corporate information. VCs have access to such information via privately negotiated information rights. Professionbal secondary buyers such as DST or Millenium probably have access to company information, as they bought shares from employees with the full cooperation of the company.

The way forward

Interestingly enough, this is also the path that activity on Secondmarket  seeems to be taking. In 1H 2012, the number of ‘accredited investor’ buyers dropped by 5x to 6% of the volume, compared with 27% in 2011 FY. Also, the share of ex-employees as seller dropped by 3x. Ex-employees represented 80% of the transactions in 2011, compared with only 24% so far this year. Remember that Facebook implemented an insider trading policy preventing current employees from selling shares in 2011. Also notable is that almost 60% of shares sold in 1H 2012 were preferred shares, which means that sellers were likely institutional shareholders as opposed to employees.

These 2012 numbers point towards a more muted private market based on activity from professional participants(institutional vs merely ‘accredited’ individuals) with an established relationship with the company, and who transact with the full collaboration of the company.

This is not surprising as Secondmarket recently switched it’s model from one were participants could trade shares of any company, to one where companies control the trading of their shares on the platform, pre-select buyer and sellers and have to provide the market with a modicum of financial disclosure. Such company sponsored transaction are I think the way to go forward for the private markets, or perhaps a return to how to market operated pre-Facebook buying frenzy.

More disclosure by private companies and a direct relationship with potential buyers of their shares are the way to go forward, it could however turn out to be less lucrative for Secondmarket than the 2011 trading of Facebook shares. The WSJ pointed out :

“(…) a month before the social network’s shares jumped to the public market, SecondMarket laid off about 10% of its staff. And while it continues to trade shares of hot private companies, these deals can offer limited rewards. A majority of such companies pay SecondMarket a flat rate to manage a transaction in which the company itself has already selected those that will buy its stock.”

The WSJ goes on: “SecondMarket’s primary asset is the collection of well-heeled, accredited investors on its platform. Fund managers that specialize in oddball investments are anxious to tap into that money pool and will pay SecondMarket a percentage of the cash they can raise.”

To follow up on my posts on US financial regulations concerning private shares resale, here are the concrete steps one should take to effectuate a sale and transfer(from the seller’s pov):

  1. find a buyer for your shares. This has to be someone from your existing network. US laws prohibit ‘general solicitation’ of private shares, meaning you can only offer them to people that you already know. Also make sure the buyer is an accredited investor. This can be done by having the buyer sign a simple statement to that effect, no proof of income or assets are needed. (you need to  ‘reasonably’ be able to presume the person qualifies)
  2. When you have found a buyer, draft and execute a Stock Purchase Agreement(SPA) between yourself and the buyer. The SPA should take into account the common restrictions  found on private company shares, such as the Right of First Refusal of the company and preferred shareholders. Templates for SPA are available
  3. After having executed the SPA, if you haven’t done so already, notify the company of your intent to sell. This will trigger the Right of First Refusal procedure, which can take a few weeks or even a month. The company will have to go through the procedure and basically decide whether they want to preempt your deal and buy the shares from you or find out whether any of the preferred shareholder wants to buy the shares from you.
  4. When the outcome of the above is known, the company will notify you of it. At this point you will know whether there are any shares left to sell to your buyer, or whether all of the shares that you wanted to sell have been bought by the company and/or other shareholders preemptively. Even if the company buys all the shares, it’s not a big deal for you since they will have to pay the same price that your buyer was willing to pay. However it will matter for your buyer, and this is why your SPA should take this into account.
  5. Notify your buyer of the above, and ask him to transfer you the purchase price.
  6. When you have received the purchase price, sign a Stock Power and send it along with your stock certificate to the company, directing it to transfer the shares that you sold to the buyer. Send a copy of all this to the buyer as well. If this is required by the company, you will also need to get yourself a legal opinion about the legality of your transaction, and send it to the company as well.
  7. When the company receives all the above, they will change the name of the shareholder in their registry and issue a new stock certificate in the name of the buyer.

Done Deal!

The risk of insider trading for a shareholder of a private company is completely different from that for the shareholder of a public company. This is due to the fact that private companies do not report to the public.

Public companies by their nature periodically report information to the general investing public. This means that as a shareholder you have access to the same amount of information as anyone else of the investing public, whether they own shares or not. In such a situation, the risk of insider trading arises if, as a shareholder or otherwise, you possess so called ‘material non-public information’. Nonpublic information is information that is not available to members of the general investing public. Such information is a rare commodity in the context of public companies, and is usually obtained via conspiracies involving company insiders. The findings of the Gupta trial provides a good example of such a conspiracy.

If you own shares in a public company, bar exceptional circumstances where you have obtained nonpublic information, the risk of insider trading when selling your shares is low.

Private companies on the other hand do not disclose much to the general investing public. In fact, they almost never disclose anything to the public. The few people aside from senior executives with access to company information are the institutional shareholders such as VCs, who have access to information by way of privately negotiated information rights. Also employees in general will have had access to varying levels of corporate information.

This creates a particular set of problems for a shareholders wishing to sell shares: as a shareholder there is a good chance that you have had access to information that the general investing public will not have had access to, either because of your information rights, or because of your employment at the company. This means the risk of committing a de facto ‘insider trade’ when selling your shares to someone from the general investing public is much higher for shareholders of private companies than it is for shareholders of public companies. In the context of a private company, you might possess nonpublic information simply because you worked at the company.

While it seems that many in the tech industry think that insider trading does not apply to private company stock, this is a mistake that could cost dearly. If you wonder whether the SEC really is looking into insider trading at private companies, here is the proof that they do.

So what can private companies do to reduce the risk of insider trading for their shareholders who wish to sell shares? The answer seems to be that the company should make information available to the buyer of the shares, in order to reduce the risk of insider trading for the seller. Ideally this should be the same information to which the selling shareholder has had access.

To quote from The Facebook Effect: Secondary Markets and Insider Trading in Today’s Startup EnvironmentOnly the startup firm itself can effectively make available to counter-parties the kind of information that would ensure that a sale or purchase does not run afoul of the prohibition on insider trading. It is therefore prudent for the company itself to set the terms under which its employees, consultants, and advisors can trade in its securities.

So ideally shareholders of private companies should only attempt to sell shares to buyers who have had access to the same level of information as the seller themselves, which can practically only be achieved by having the company cooperate with the transaction.

So what do companies need to do to prevent their shareholders from selling outside of this scope? The companies could adopt an Insider Trading (IT) policy.

The above quoted article provides some cues as to what such a policy should entail:

  • Prepared by outside securities counsel, an IT Policy should make clear to all company employees that trading by insiders may in certain circumstances be illegal under federal securities laws
  • The IT Policy should establish a general principle that no employee should trade or cause someone else to trade the company’s securities while in possession of material nonpublic information.
  • The IT Policy itself should help educate rank and file employees, who are very likely not to have any familiarity with securities law, by providing clear examples of what material information means.
  • Examples of material information are financial information such as revenues, operating margins, or net income; risk factors such as potential environmental liabilities; and background information on key executives.

The article concludes that “although the founders of, and investors in, early-stage companies may chafe at the restrictions that an IT Policy places on liquidity, it is important that their counsel remind them of the far more catastrophic risk of facing liability for insider trading. ”

Further discussion on the topic can be found on Quora.

In 2011-12 the media focused on the trading of Facebook stock via brokers such as Secondmarket and Sharespost (who became a broker/dealer in early 2012, after settling with the SEC over allegations of operating as an unregistered broker). What received less attention was the fact that Facebook, as early as 2008, pioneered a form of engagement with common shareholders and outside secondary buyers that  resulted in liquidity for employees and presumably a huge HR benefit for the company itself.

A recent WSJ article reveals to us how the firm, as far back as 2008, through the efforts of its then CFO Gideon Yu, was actively courting sophisticated secondary investors to promote liquidity to its common shareholders (mainly current and former employees). This first resulted in $10m in common stock being acquired by Millenium Technology Value Partners from a dozen employees in 2008.

A year later, DST bought $100m worth of common stock form employees, in another deal orchestrated by the company.

It should be noted that both transactions were the direct result of Facebook reaching out to investors and building relationships with them, even though the transactions themselves were between shareholders and the outside investor. This can be seen from Mark Zuckerbergs comment on the deal at the time(emphasis is mine):

While individuals must make their own decisions about participating in this program, I’m pleased that the price DST is offering is much greater than the price originally considered last fall. This is recognition of Facebook’s growth and progress towards making the world more open and connected.”

Essentially, Facebook built relationships with outside investors, which paved the way for shareholders individually selling to those investors, without the need for a broker. It should also be noted that these secondary transactions were for the benefit of all common shareholders, not just the founders.
The Facebook deals were very different from limited secondary components of funding rounds which often allows founders to partially cash out. Such ‘secondary deals’ are often limited in scope and benefit only the founders, while being used as a sweetener by VC firms(Bill Gurley of Benchmark reportedly called these practices ‘bribes’).
Twitter’s massive secondary component of it’s 2011 funding round on the other hand clearly was orchestrated to provide broad access to liquidity to its shareholder base, similar to the preceding Facebook deals.

Secondary markets are often referred to by company management and boards as a pain and distraction that they wished would go away. It seems Facebook really was a pioneer in addressing and solving those problems, turning the private secondary market to its advantage.

This is best illustrated by a quote from a recent Millennium press release:

“Facebook solved one of the biggest problems facing emerging high-growth companies,” says Millennium’s Sam Schwerin. “Through the company’s unprecedented use of secondary purchase programs that allowed stakeholders to achieve early liquidity, Facebook was able to develop its business model in the relative calm of private company status. The company was able to avoid the inevitable pressures to go public too soon.”

Over time, Facebook developed ways of addressing some of the challenges and complexities of secondary market activity. Schwerin adds, “Facebook pioneered the trend of ‘taking control’ of the secondary process. Having learned from Facebook’s experience, leading companies are now selecting institutional partners for liquidity transactions, using secondary liquidity to attract and retain key talent, and aligning secondary activity with strategic goals, rather than allowing it to become a random or distracting process.”

What is most interesting is that Facebook achieved this without resorting to using one of the well-known online marketplaces for private stock such as Secondmarket or Sharespost. While its stock did trade on those platforms, this was through ad hoc transactions where shareholders sold to investors unknown to the company.(While Secondmarket as since shifted to offering company controlled ‘liquidity programs’, Facebook never signed on to those and its shares traded without the company’s involvement on the platform).
While the transactions on these marketplaces did get the bulk of media attention in 2011, they represented deals that went ‘through the cracks’ of Facebook’s control over its shareholder base. Perhaps Facebook’s focus shifted to the public markets in 2011, and the lack of a large orchestrated liquidity program resulted in so many shares being sold on the open market via Secondmarket and Sharespost.
One could argue that as Facebook became so well known by the general public, a market for its shares was created by buyers unknown to the company and with very little access to information about it. The only reason those buyers were willing to buy stock was the public reputation of the firm and the expectation that is was soon to go public in one of the most anticipated IPO. An unprecedented situation and probably the last time we will come across it.

The conclusion we can draw from the Facebook activities in 2008-09 is that when companies realize that the demand for liquidity becomes a distraction for their employees, it is best to address it directly by building long term relationships with selected outside investors. Such direct relationship between the company, its shareholders and those outside buyers pave the way for commission-free private transactions(no broker = no commission), while ensuring that those transactions are in full compliance with corporate policies and financial regulations.

In mid 2011, right in the middle of the private FB shares boom, the Fortune Brainstorm Tech conference in Aspen hosted a panel on secondary markets and private companies. Both venture capitalist and company CEOs expressed concerns about the pain the secondary markets were creating for private tech companies. This was discussed in a NYT blogpost

It’s a distraction,” said Dick Costolo, Twitter‘s chief executive. “We and Zynga and Facebook have retroactively had to put lots of policies in place to constrain that.”

New start-ups are writing bylaws that govern sales of shares on the secondary market, said Matt Cohler, a partner at Benchmark Capital. He encourages start-up founders to do so.

About a year later, at an April 2012 event organized by Wealthfront, Doug Leone from Sequoia was heard saying that “within Sequoia Capital companies, the door is getting shut on the secondary markets.” He further said that “companies are enforcing stricter trading rules on employees and “rights of first refusal all over the place,”

A company can prevent current employees from selling (but in doing so risks creating an incentive for people to leave), and hope to prevent any addition to its cap table by consistently exercising its right of first refusal when an ex-employee tries to sell to an outsider.

Companies could do even better by engaging with shareholders through Investor Relations(IR). Two way communication with and the provision of information about a company’s prospect to common shareholders could reduce the demand for liquidity from (ex-) employees. It could also help companies gauge the need for liquidity and understand where it comes from.

At the 2011 Fortune panel, Frank Quattrone, the investment banker, said that whether private markets are beneficial depends on the employees’ motivation for selling their shares — cashing out, versus buying a house so they can concentrate at work.

If the need for liquidity proves to be a distraction for employees, companies could through their IR program reach out to pre-selected dedicated investors of their choosing, and work with them in setting up a liquidity program for common shareholders. Such deals are already being done, and a dedicated IR platform would make this more efficient.

At OpenShares we are building a shared platform for IR aimed at private companies and specifically tailored to meet their secondary market related needs. As we are not a broker, our goal is not to generate trading volume, it is rather fully aligned with the IR goals of the company. If a company wants to constrain the secondary market in their shares, then our platform could serve exactly such purpose. If companies do want to promote a form of limited and controlled liquidity, this could also be done through the platform by engaging with investors of their choosing. Companies, their shareholders and potential outside investors could build relationships directly with each other, paving the way for commission-free direct transactions between shareholders and company vetted outside investors. Companies could through communication manage the valuation and legal risks that arise from such secondary transactions, and ensure that transactions are in full compliance with both corporate polices and financial regulations.

In other words, OpenShares will allow companies to pro-actively address the needs of their common shareholders and manage their secondary market.

I believe private companies need to start building more meaningful relationships with their common shareholders. Why? For two reasons:

  1. an inexorable increase in common shareholder count. In the past, the 500 shareholder count limit forced companies from Google to Facebook to seek the public markets, as breaching the 500 limit would subject them to the oversight of a public company anyway. With the Jobs Act, that has now been increased to 2.000. This means private company will be able to ramp up their employee share ownership while staying private all the longer.
  2. the rise of the secondary market. This will further grow the number of shareholder, as each trade on average grows the shareholder base by one, assuming shareholders don’t sell their entire holding in one trade. Even if secondary markets have not reached the masses of private companies, their perceived benefits certainly have reached the masses of private company shareholders. This also creates pressure for companies to engage with their common shareholders and understand where the demand for liquidity comes from.

For companies, a rise in shareholder counts and secondary transactions create various headaches, which were very well summarized in this quora answer:

  • Increase in total number of investors (which causes securities law compliance issues and adds to administrative burden).
  • Inability to control the identity of shareholders. (Even if the company has a right of first refusal on transfers of shares, which is common, if the buyer offers a high enough price and/or the company doesn’t have the cash lying around to exercise the ROFR, the shares can end up in anyone’s hands.)
  • Leakage of financial and other proprietary information. Buyers understandably want to know as much as possible about the condition and prospects of a company before paying serious coin for a relatively risky, illiquid investment. The company is put in a tough position where it either cooperates and discloses financial information under Non-Disclosure Agreement to the potential buyer or refuses to cooperate, putting strain on some relationships and encouraging buyers and sellers to circumvent the NDA (tough to prove).
  • Messing up 409A Valuations, which the company pays real money for. By setting a new market price for the shares, secondary sales can force the company to price stock option grants higher than it would like going forward, undermining the incentive value of equity.
  • Inability to control the process. Most private companies would prefer no secondary sales be made at all before an Initial Public Offering (subject to some narrow exceptions), but as the lesser evil, the company is better off doing a controlled, structured process the way Facebook reportedly does.
  • Distraction and resentment among employees. There are always equity haves and have-nots, but it’s worse with private sales where investors usually don’t want to bother unless the block of shares is large enough. So generally top execs and founders have no trouble selling while rank-and-file employees may not have enough shares for anyone to bother, leaving them SOL.
  • Complex legal documentation and administrative burden. The standard documents used by a firm like SharesPost can run 30 pages. Selling shares in a publicly traded company requires only a couple pages in most cases. Everything has to be vetted by the company’s (inevitably overworked) legal and finance teams.

Companies can resolve these problems with IR tools. Its all about communication with your common shareholders really. First of all, employees and other common shareholders might be clamoring for secondary liquidity, but the real reason might simply be a lack of engagement and information coming from companies. An ex-employee might want to cash out on his shares simply because he now feels disconnected from the company. An IR campaign aimed at common shareholders could do a great deal to reduce demand for liquidity in the first place.

Shareholders might also feel the need for liquidity due to their personal financial situation. When they reach 30 and get their first child, the need for cash for a deposit on a house might be greater then that for an ownership stake in a risky venture. If the need for liquidity becomes a distraction for current employees, or prevents the company from competing with publicly traded rivals over talent, a private company might consider pro-actively enhancing the liquidity of its common stock.

Again, such liquidity can be achieved through IR tools as well. Back in the days that ‘secondary market’ was not yet a buzzword, transaction were occasional and conducted with outside buyers with a long standing relationship with the company. the following quote from John Glynn is telling:

“These were very occasional transactions, and it was done the old-fashioned way. You earned the respect and trust of the company, and they ended up wanting you as a shareholder.”

Another example is the leading role played by Millennium Technology Partners, a pioneer secondary investor in VC backed companies. Here is an excerpt from the same business week article

Millennium Technology Value Partners was among the first such investment funds, founded by two veterans of buyout firm Blackstone (BX). The fund spent the early part of the decade buying shares in startups from executives and investors that needed cash. In one of its first organized, companywide “liquidity programs” in 2006, Millennium bought shares from employees, executives, and investors of TellMe Networks, a Silicon Valley voice recognition company. Microsoft acquired the startup the following year, reaping Millennium bounteous profits. These transactions were still tame, well-orchestrated, and carefully negotiated affairs, always conducted with the imprimatur of the company in question. And then Facebook changed everything.

The frenzy that followed to acquire FB shares did not represent the dawn of a new era, which would see the private secondary market virtually replacing the public markets. It was just a blip, albeit a very big one, in the history of the secondary market.

Companies wishing to pro-actively enhance the liquidity of their common stock for the benefit of their shareholders should do so the ‘old fashioned’ way: by building relationships with one or several sophisticated secondary buyer such as Millemium.

By communicating with existing common shareholder and selected outside potential secondary buyers on an equal footing, private companies can assert control over their secondary share price, their shareholder base and the information used as the basis for transactions. This would effectively deal with the above mentioned problems, as well as with the risk of insider trading arising every time a shareholder with some corporate information sells to an outsider with none.

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