Private Secondary Market - The Utility

Private Secondary Market has been gaining prominence due to the eye-popping valuations of a number of social media companies in such markets where accredited investors (requirement by SEC for exempted transactions as defined under Regulation D of the Securities Act of 1933 to ensure that the participants are sophisticated with ability to bear the economic loss in case any in the investments made and they abide by the resale restrictions as placed by the company whose stock is being traded) generally trade on private companies. This Marketplace allows privately negotiated sales transactions to trade illiquid, restricted securities and facilitate alternative investments like private company stock, collateralized debt obligations, bankruptcy claims and auction rate securities. The investors are promoted to capture the illiquid premium and hold on their stakes for longer period knowing that their assets are not largely co-related with the public market. Eminent players providing such platforms are: Gate Technologies, SecondMarket, Xpert Financial and SharesPost. Through these markets, the small cap early stage start-ups are now getting access to funds without getting involved into the arduous legal process and costly financial disclosure required under the Sarbanes-Oxley Act. Since the trading occurs without any declared financial information of the traded stock, this marketplace attracts investors with a higher risk tolerance such as an archetypal startup investor. LinkedIn is one of the first social media companies to have come out of the secondary marketplace and graduate to full-fledged IPO stardom.

With the advent of this marketplace, investors no longer need to wait for a company’s public listing and private companies get the option to create their own customized liquidity program. The platform currently does not support shorting, margin, derivatives or manipulation and hence seems to be more untarnished. Investors here are actually more interested in flourishing the emerging private companies and make them capable of generating optimal investment returns. With the likelihood of a higher valuation, an increase in brand awareness and a greater ability to attract additional capital, there has been a surge in the number of U.S. based companies participating in the secondary marketplace. 

As per SEC rule, if a private company exceeds 500 shareholders, then it has to register all its equity securities with SEC and start disclosing its financials which is what Facebook might have to follow soon as it has passed this limit. But recently, a new legislation to revise the 1964 Securities Acts Amendments has been introduced which include raising the private company’s shareholder’s count from 500 to 1000 and exempting accredited investors and company employees from this count. Such a change will certainly give a thumbs-up to the marketplace for private shares by enlarging the potential investors’ pool in a company. This will tempt companies to remain private a bit longer using the liquidity derived from the secondary marketplace and enable them to emerge stronger for an eventual public exit. Thus instead of prematurely going public and risking their stocks in the hands of shorters , traders and manipulators, the companies can more effectively control their liquidity and shareholder base using this marketplace.