Friends, we haven't been the best bloggers recently, and for that we're sorry. We have been sharing our thoughts in short-form, though, so please do follow us on Twitter
. During our blog hiatus, we've learned a lot, met great folks, and have become all the more determined to fix the broken secondary markets for private shares. For much of the fall and winter, we were in California, establishing our footprint in Silicon Valley, under the auspices of our awesome investor, Dave McClure and his fund, 500 Startups. Of all the things, big and small, we've learned the last few months, we highlight three paradigms about secondaries.
1. The company is a key stakeholder that needs to be taken into account.
We've spent a lot of time studying what we call "Secondaries 1.0", the period from 2009 to mid-2012 (culminating in the Facebook IPO). Brilliant people, who were and continue to be key players in the secondaries world, such as Dave Crowder
, Lou Kerner
, Adam Corey
, and Breck Hancock
among many others, have shared their wisdom and experiences with us.
Why was Secondaries 1.0 unable to sustain? Because every time an employee listed his shares on SecondMarket or SharesPost, the company was left holding the bag. The company inherited the headache, paperwork, and costs associated with the share transfer and also had to deal with all of the cap table damage and the strangers who would soon have voting, information, or other important rights over the company. Because of these issues, companies more or less discouraged the use of secondary markets, and consequently, the liquidity and activity on secondary platforms dried up.
Our structure makes secondary liquidity hassle-free for companies. Through our platform, shareholders get liquidity and investors get investment access to great private tech companies, but the problems described above evaporate:
In short, the company does not have to incur the brain damage associated with diligence of a new shareholder and exercising its right of first refusal.
- There is no recurring change to the cap table.
- There is no transfer of voting, information, or other control rights.
2. Not only does the company need to be taken into account, it needs to control the process.
It's our firm belief that to make secondaries work, you need company buy-in. That's why we're making Secondaries 2.0 with the company in mind. Not only does this mean reducing the company's hassles, but the company should also have some control over the process.
We've heard multiple anecdotes about the grey-market transactions in private shares. Here's a typical example. A broker scans LinkedIn and finds employees of [insert name of hot tech company]. The broker calls an employee and tells her that there is demand for her shares. She asks, "how much?" And the broker quotes a price per share. Employee responds, "But does that account for the partnership with [name of Fortune 100 company] we're about to announce?"
That's just one example of another reason why companies don't like employee liquidity. So we want to allow companies to control the process: who gets to sell, how much, and when. By controlling the process, companies will mitigate the risk of leakage of sensitive information and will be able to anticipate and deal with the implications of employee liquidity without being blind-sided by a right of first refusal.
3. Efficient and liquid secondary markets for private shares are more important than ever.
Secondary markets for private shares are dysfunctional/non-existent at a time when they are most needed. Sure, founders have back-channels for liquidity through their VCs, but what about employee #26 or the angel investor who committed early?
Companies are staying private longer and yet shareholder liquidity needs have not changed. As a proxy for this claim, consider that the average horizon to IPO for a VC-backed company in 2001 was 5.5 years; in 2011 it was over 9 years (source
). No doubt, it's even longer now. Compounding this is the growth of crowdfunding (by many measures
, it is doubling year over year). AngelList and FundersClub have turned VC investing on its head. As these and other platforms continue to democratize venture investing, the private shareholder base will continue to grow.
EquityZen will be the backbone supporting the entire system. Even today, a functioning secondary market for VC-backed equity is badly needed. Factor in crowdfunding, and you quickly see that there needs to be a pressure valve--in the form of secondary liquidity--for the growing private shareholder base.
This is what we're building at EquityZen. It continues to be a fun ride.
- Atish, Phil, and Shri