So-called secondary markets which engage in brokering deals between shareholders of private companies and outside investors are a horrible and dangerous thing. I fully believe that these markets should be regulated by the SEC, which would largely obviate the need for secondary markets in favor of existing markets.
In general I'm a huge fan of free and unfettered markets. I think regulators are undermanned and outgunned by those who stand to profit by circumventing regulations, an imbalance which makes enforcement of regulatory rules a capricious endeavor. But I know a sucker's game when I see one. Individuals buying shares of private companies without access to the standard information available to shareholders of public companies are simply asking to be fleeced. In all things related to trading securities, you don't have to ask people to take your money twice.
The above is strictly my personal opinion. I could be wrong. But I'm not.
Now that we know where we all stand, Breakout invited Sharespost.com CEO David Weir on to discuss the rapidly growing second market for private companies. Weir's firm connects buyers and sellers of private companies. Sharespost et al allow individuals with totally illiquid stock in private companies to cash out before the company goes public. In itself this is a good thing, at least until you consider who the buyers are.
Businesses such as Sharespost and rival Second Market -- whose CEO joined Breakout in early Spring -- are booming, thanks to the exploding demand of smaller investors wanting a piece of companies like Facebook, Twitter, Groupon and Zynga before they go public. In theory, this gives private investors access to an investment club previously reserved for venture capitalists and investment banks.
Sharespost and others like it are entirely legal, presumably ethical, and don't set the prices but rather facilitate (read: broker) a deal between stakeholders and individuals. Sharespost does its best to close the information gap between buyers and sellers by giving members access to third-party analysis from a firm called neXtup Research. This enables would-be investors to get some perspective on what nexXtup feels a company "should" be worth.
So Sharepost is doing what they can for the relatively little guy. For their efforts both as a business model and above-board operation Sharepost is totally legit. I recognize and appreciate that.
But here's the rub: Real information about private companies is both limited and selective. Part of preparing a company for an IPO is disclosing information like expenses, profits, tangible growth plans, strategy and potential risks. This information is issued in offering prospectuses and the like. Companies not subject to the regulations of traditional markets such as the NYSE and NASDAQ can tell you pretty much whatever they want. "Whatever they want" typically includes information which casts a company in a favorable light.
Put it this way: When someone asks you about your kids, do you say nice things or list your grave concerns about their future and upside potential?
Sharespost only allows sellers who are currently unaffiliated with the company in which they are selling shares. "Unaffiliated" only means not working for the company at the specific moment of the sales. Sellers can include VC's, consultants, ex-employees or anyone else holding stock. The problem is that any and all potential sellers of these shares have material, non-public information about the shares being sold. I'm no lawyer, but such transactions seem to be exactly the SEC's definition of insider trading.
Quoting the SEC: "Insider trading is a term that most investors have heard and usually associate with illegal conduct. But the term actually includes both legal and illegal conduct... Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security."
The "breach of fiduciary duty" part of the above may give the secondary market a legal loophole. Beyond that, here's my opinion: Selling shares of a private company is exactly, precisely and in every way insider trading. By buying shares of private companies through secondary markets, individuals, accredited or not, are willingly engaging in the wrong side of an insider trade. The buyers are the quintessential suckers at the poker table, regardless of whether they make the couple hundred thousand a year needed to qualify as accredited.
None of this makes CEO David Weir a bad guy. We didn't interview him to pick on him or his business. He's clearly a capable businessman running a completely legal operation. What's more, I actually encourage readers to check out Sharespost.com for themselves. Registration is free and the site makes for great theater while providing insight into what's going on in the world of non-public companies.
That said, I'd be lying if I even implied that I think anyone should be buying these shares. You'll hear stories of people making money by trading ahead of IPOs, but the reality is that most of the outsiders are going to lose and lose big.
I'm not here to curry favor with private companies, public companies, or even our guests. My job is to help and inform you, the reader and viewer. If I didn't tell you what I thought, I'd be withholding my own material and non-public information. As far as I'm concerned, the best and only advisable way to accumulate shares of Facebook and other non-public companies is to try to get a job with them, marry someone who already has a job with them or become a venture capitalist with a high-profile firm.
I truly believe any other method for getting a piece of pre-IPO companies is a sucker's play. Please let us know what you think. Comment below or email us at Breakoutcrew@yahoo.com.
- secondary markets
- investment club
- venture capitalists
- investment banks
- fiduciary duty