Building a Second Market to Make Way for Wall Street 3.0
By Kathryn Glass
Published July 16, 2010 | FOXBusiness
At the height of the credit crisis, as formerly liquid markets seized up and assets that were considered to be as liquid as cash froze almost overnight, SecondMarket saw possibility. Now, five years since its inception, this illiquid-asset broker is taking off, making a name for itself by facilitating the sale of stock in private companies like Facebook and LinkedIn, and doubling its market participants every six months.
“At the end of 2008 we had about 2,500 buyers and sellers. At the end of 2009, we had about 6,500. We just hit 14,000 and we’re only halfway through 2010,” said SecondMarket’s founder and chief executive officer, Barry Silbert.
Simply, SecondMarket is an online illiquid-asset marketplace; it’s what you might get when you cross a traditional broker-dealer with an eBay-like (EBAY) electronic auction platform. Sellers list their assets, which are too illiquid — meaning they don’t have a large enough base of buyers and sellers — to trade on a traditional exchange, and the company notifies potential buyers in its client base or institutional investors of the new listing. The firm eventually has its traditional traders and salesman work on getting the bid and the ask price to a point where both buyers and sellers are satisfied, but the initial process is done online.
This firm’s technological approach is not wholly unheard of; start-up Sharespost.com employs a similar methodology for the sale of stock in privately-held companies, by using an online platform to facilitate trading. Yet SecondMarket has managed to garner the attention of big-name investors, as the company received $15 million in Series B venture capital funding from prominent Asian mogul and Facebook investor Li Ka-shing’s foundation and Singapore sovereign wealth fund, Temasek Holdings PLC. Last year, the company saw $35 million in revenue; this year, they’re on track to do between $50 million and $55 million in revenue.
The business model involves SecondMarket acting as a standard broker-dealer for sophisticated and accredited investors, facilitating trades and taking a commission that ranges from 2% to 5%, depending on the deal, equally split between buyer and seller. What makes it different from many big banks is that the firm doesn’t take positions, meaning it’s not betting against the clients for which it trades.
SecondMarket currently trades nine different asset classes, including auction-rate securities, bankruptcy claims, limited partnership interests and restricted securities, to name a few. Sales of stock in privately-held companies, while less than 25% of the firm’s revenue, is the fastest growing part of the business and has been getting the most attention, as SecondMarket facilitates the sale of stock in big tech names like Facebook, Zynga and EHarmony. Silbert says he is probably most passionate about this facet of the business because he thinks it a crucial step in revitalizing the market.
“I think the public markets have gotten so far away from what they were created to do — something like 70% of public trading in the public is done by high frequency trading,” Silbert said. “The public market in a lot of ways has become a bit of a casino and all these factors have made it not that attractive to go public anymore.”
Silbert explained that he hopes the secondary market can become a viable third option, aside from going public or selling their company altogether, for entrepreneurs and venture capitalists to get liquidity out of the business. Others share that hope, particularly in the venture capital community. Mark Heesen, President of the National Venture Capital Association, said the average time it takes for a start-up to go public from the period when the venture capitalists initially provide funding is now a little less than 10 years.
“We want to see our entrepreneurs hungry but we don’t want to starve them and I think a lot of them were starving,” Heesen said. “In the past, seven years was a reasonable period, but 10 years is a bit more difficult…and you can see where entrepreneurs and these early employees will have a difficult time looking at things from a 10-year perspective versus a 5 to 7-year perspective.”
Heesen concedes that not everyone in the VC community sees the sale of private company stock as a good thing. He said some investors think this ‘early exit’ option could become a disincentive for entrepreneurs who are still building their companies. Nevertheless, Heesen still thinks the majority understand that the liquidity option SecondMarket and others are offering to entrepreneurs and early employees is a good thing, particularly in a tough economy.
“When times are great and you have a good possibility of going public you want to hold their [entrepreneurs’] feet to the fire until that company goes public,” Heesen said. “But in difficult economic times when the IPO door is shut you have to look at that and recognize that the entrepreneur needs help, and SecondMarket helps that process.”
Facebook, for its part, declined to comment on the secondary markets, but the social-networking giant did admit it implemented an “insider trading policy,” earlier this year to address the sale of its stock in the secondary markets, in an effort to “better comply with insider trading laws and to protect the interests of the company and its employees and shareholders,” according to a Facebook spokesman.
Ken Sawyer, managing director of Saints Capital, has used SecondMarket to purchase private company stock with his firm, a merchant venture capital firm that makes late-stage investments in growth companies that are often venture-backed. Sawyer said what SecondMarket has been doing for venture-backed private companies has been crucial, as the IPO market dried up over the past two years, but he thinks the company needs to work to expand the number of private companies whose stock they trade.
“We are very happy that those guys exist and think they’re providing something of value — the issue is that there’s a perception that this is a broad and deep market, but 80% of the dollar value of these trades is a couple of names,” Sawyer said. “There are over 7,000 venture-backed companies and SecondMarket’s dealing with 5-6 names; they’re not providing liquidity to the other 6,995 names out there.”
Silbert said private company stock will continue to be an important asset class for his company. The firm is closing in on $300 million completed private company stock transactions since the market was launched in April of 2009, and Silbert said that longer term, the vision is a lot bigger than SecondMarket’s identity as “the market for Facebook.”
“I’m really excited about what we’re doing and we really think we’re going to change the world,” Silbert said. “With what’s happened the last year or two and the trust that’s been destroyed on Wall Street — I think in a lot of ways we’re Wall Street 3.0: 1.0 was on the phone and in-person trading; 2.0 was all about algorithm trading; 3.0 is using technology and doing things in a transparent way to bring trust back into the system.”