Hot demand for private internet companies’ stock

Hot Demand for Private Internet Companies’ Stock

August 24, 2010 7:55 pm
By David Gelles

On August 5, an unnamed investor made what many may consider a good bet – he bought a small stake in Facebook, the fast-growing social networking site.

However, as a private company, Facebook has not disclosed details of its financial performance and the $76-a-share the investor paid has raised eyebrows from Wall Street to Silicon Valley. The trade gave Facebook an implied valuation of $33.7bn, making it worth more than most companies on Nasdaq.

The spike in prices is driven by a big mismatch in supply and demand, prompted by the decision by some of the better-known private tech companies, such as Facebook, Twitter, LinkedIn and Zynga, to delay going public while the market for IPOs remains shaky.

The appetite for shares in private online ventures exists because a new breed of investors has created funds with the sole purpose of acquiring stakes in these companies. The fierce competition among them to own even a tiny slice of some of the hottest operators in Silicon Valley is driving prices up.

“This is a stock market,” says Mark Heesen, president of the National Venture Capital Association. “In an environment [where] you have 500 point swings, you can win and you can lose.”

On SecondMarket, a site that matches buyers and sellers of private company shares, there is $350m in active listings. Of the nearly $300m in transactions on the site since April 2009, 40 per cent has been for Facebook stock.

This active trading of secondary shares brings fresh challenges for these companies. Security and Exchange Commission rules say that a private company should have no more than 500 shareholders, a high proportion of which are usually employees.

Facebook has assigned a right of first refusal to existing shareholders in an attempt to keep the total number of investors down. Tiger Global, the hedge fund and an existing Facebook shareholder, is said to be buying Facebook stock at $60-a-share at the behest of the company. Facebook declined to comment, while Tiger Global could not be reached for comment.

LinkedIn, too, is trying to clamp down and has said that for the remainder of 2010 there should be no secondary share sales unless the buyers are existing shareholders, according to Adam Oliveri, head of private company markets at SecondMarket. LinkedIn declined to comment.

Another SEC rule says that buyers and sellers of private company shares should have access to the same data about the company’s financial performance. This leaves employees looking to sell their shares with two options: either disclose non-public material data about their employer and violate confidentiality agreements, or risk breaking SEC regulations.

In an attempt to head off any potential legal troubles, in April Facebook instituted an insider trading policy that stated that no employee could sell stock on the secondary market outside specific trading windows set by the company.

Nevertheless, these measures appear to have done little to reduce trading, with activity picking up in recent months.
Some analysts caution that these investments are being made without sound financial discipline. Bo Brustkern of Arcstone Equity Research, which analyses private companies, says investors’ desperation to own the stock can lead to imprudent actions.

“Purchasers may be willing to pay a premium for access to private stock they would not otherwise have, thus overpaying.”
But with demand outstripping supply, many investors are betting and winning with trades in the secondary market.
“The great majority of shares purchased on our platform a year ago have seen substantial gains,” says Greg Brogger, founder of Sharespost, another website that matches buyers with sellers.

Ken Sawyer, founder of Saints, a private investment firm, acquired two batches of Facebook stock in 2008 and has already reaped the rewards. “We bought at significantly lower prices than what it is now selling for,” he said. “We’ve sold a very small percentage of what we acquired and made almost our investment back.”

Mr Oliveri believes private technology companies could further tighten up their rules in an attempt to put an end to the intense secondary trading.

“It’s possible that in the future companies will exercise more contractual control,” he says.
Watchdogs, too, may take a closer look at the market. “There’s going to be more regulatory scrutiny because there’s going to be so much more transaction volume,” Mr Oliveri adds.

But until that happens, many investors who are sitting on much sought-after Facebook stock appear convinced that once the social networking site goes public it will become one of the most valuable internet companies around.

“We still hold some Facebook stock,” says Mr Sawyer. “We believe over time that it will trade at higher valuations than where it is today.”