I had a conversation with Scott Rafer on Skype Sunday night, where I requested a video interview of him on SecondShares so he could express his views on the secondary sale of private company stock in companies like Facebook, Twitter and Zynga, as well as the recent angel investment “bubble”. Scott declined to be interviewed by SecondShares, expressing his concern that we are “legitimizing” the private secondary shares market, which he feels strongly against.
Apparently there appears to be a growing sentiment among a select few within the startup community that the secondary markets should be avoided like the plague. This post is in response to a post written by Scott attacking us (but not naming us) and the secondary market for private company stocks, and is intended to clarify our mission and the value of the secondary market for private company stock, since its apparently not yet clear to some rather influential and smart individuals within the startup community like Scott.
Interestingly, after our ten minute conversation on Skype, Scott responded by writing a blog post that started with “There’s No Insult Intended…”, yet in his blog post he said:
“…as is clear, Google is forever. I’m not going to voluntarily have my name indexed alongside his domain.”
SecondShares hopes to provide a platform for all parties to articulate their views on the secondary market for private company stock, and we had hoped Scott would accept our invitation to participate and provide his views.
In Scott’s post he incorrectly described SecondShares as:
“His blog covers solely the market for private stock sales. He only succeeds if it becomes a legitimate market. I am very concerned that we’re just seeing the start of a giant wave of these crappy deals and that they will total many billions of dollars in the coming years. His domain, his logo, and 90% of the articles on the site are legitimizers of this poorly considered macro reaction to the over-regulated mess we call the IPO process.”
Scott is either misinformed or unaware, but to clarify, SecondShares provides news, commentary, and Wall Street style analysis on private internet companies. We do not solely exist to report on private stock sales of internet companies. In fact, we don’t even know when the second market transactions occur.
Scott states that his concern is to not “legitimize” the secondary market, however, he addresses it on his blog. The reality of this emerging market is that Scott and many others ought to act to legitimize this market whether it be on our SecondShares site or not.
The public market’s decade long bear market burn of value in the US public equity market needs a new way to channel value creation because a chart of the S&P over the last decade demonstrates that the US public equity market is broken!
History has demonstrated that the birth of many markets has been marked by a chorus of discrediting and undermining commentary by many including the entrenched players at risk. The case in point today is the secondary sale of private company stock, also known as the second market. Some, like Scott, within the startup community are articulating their concerns.
“I’m concerned about the inevitable ripoff artists who will start shell companies solely to sell their shares on SecondMarket (or wherever). They’ll have documented some silly plan about rolling up small social game publishers, Groupon clones, or whatnot.”
Before one casts further dispersions on other legitimate business approaches and strategies such as rollups of synergistic businesses one ought to consult with one of the many wildly successful business managers greats such as Jack Welch formerly of General Electric that was noted for building one of the greatest companies in the world with such a roll up strategy, or the highly successful internet entrepreneur Richard Rosenblatt of Demand Media or even Mark Pincus of Zynga (which has rolled up quite a few application companies.) The list goes on and on.
Given the precarious state of the world’s public equity markets it is quite concerning to us that so many within the startup community are seeking to cast dispersion on a market that is so strategically critical in today’s financial environment and possibly for many years to come.
Though Scott’s contrary logic still evades us, we are the preeminent blog for thoughtful commentary and analysis surrounding private internet companies by acknowledged, seasoned and successful Wall Street professionals.
More ironic is the idea that Scott apparently believes that there can be any legitimate market that can steadfastly avoid the “crappy deals” and “inevitable ripoff artists” that he speaks of in such a way as to believe that they only exist in the realm of a market like the secondary market.
One might consider recent events such as Bernie Madoff’s escapades, pink sheet shell company scams as well as countless public stock manipulations before relegating such activities to the realm of a new market such as the one SecondShares expounds upon. Importantly, it is worthy to note that insult is added to injury in that the public market’s crimes count as its victims those that are not accredited investors, while the inevitable incidents that may occur in the secondary sale of private company stocks do not! Scott’s concerns would be much better placed on a public market of tens of trillions of dollars, rather than the emerging legitimate and the strategically critical secondary market.
While Scott may scoff at the notion of this market being a strategically critical market, the ultimate irony is that the private market that Scott fears to “legitimize” has been his personal choice of venue establishing the value of his companies! While Scott may say he raised capital and sold equity to “professional investors” (angel investors and venture capitalists) the fact of the matter is that markets have a history of broadening out and the accredited investor qualification of the secondary sale of private equity offers a protection that the public equity markets do not offer. In the end, as we all know, the world is getting flatter and to pretend there isn’t more business intelligence more firmly planted more broadly than it ever was before is to believe the realities of why the second market has the credibility and traction that it does. This is why SecondShares was established to create a reasoned voice of commentary and analysis in a market that is destined to grow in its importance and consequence. Again, we would say that Scott’s concerns would be better placed on a much larger market with less protections around the unsophisticated investors involved in investing in the US public equity markets.
To keep things very simple, in a bear market the gravitational pull of the market is such that it is directed at pulling down the value of publicly traded stocks. Importantly, we believe there is a growing trend to consider that the use of stock to attract and retain key employees as well as the use of a stock based currency to acquire strategically critical assets is mission critical and best not left to chance valuation in a bear market.
The only irony greater than where Scott chooses to blog his views on the secondary market is that he would suggest to others that they leave the critical strategic imperative of how a stock gets valued to be relegated to the whim of a public bear market rather than to an orderly, governmentally blessed and legitimate second market. It’s not likely an accident that there is more value today than ever before being captured in the companies that make up the secondary market.
Perhaps it’s not a mere oversight on the part of all these non-public companies with values in aggregate well north of one hundred billion dollars. We just doubt that that they simply forget how to file an S-4 with the SEC to go public. Ask any of the countless investment bankers chasing Facebook and the many other companies that would be gladly be shown the rubber chicken laced road shows required to go public. They are clearly choosing not to go public. There is a lesson in this for many that think that the road of running a successful company must go through the IPO door.
The strategic imperative of thoughtfully considering how a Board and a management team chooses to have their company valued may in fact best be left to a market that they can believe in; rather than a public equity market noted of late by the SEC for the largest insider trading scandal ever in history and is looking more and more like Japan’s death defying bear market of the past twenty years.
We guess the punchline is …
We were insulted! ;)
This post was edited in collaboration between Jay Gould & Bill Auslander.
General Questions & Considerations of a Secondary Market Transaction
by loukerner on April 8, 2011
Guest Post by Mitchell C. Littman, Esq.
So, what is a Secondary Market Transaction?
A Secondary Market Transaction is a negotiated private sale of restricted securities of an Issuer whose securities are not publicly traded. Some transactions are effected directly from Seller to Buyer and in some instances one or both parties may be represented by a broker-dealer who may earn a commission on the transaction.
Who are the Issuers?
The Issuers that have attracted the most market attention have been social networking and technology firms that have chosen to remain private but that have (i) used equity and equity-linked reward systems in attracting and incentivizing employees and (ii) received private equity or venture capital investments from some combination of angels and institutional investors.
Who are the Sellers?
The overwhelming majority of Sellers have been founders or early-stage employees that have left the employ of the Issuer, though there has been some selling by early stage investors (primarily angels, rather than VCs who have tended to participate in follow-on rounds). Ex-employees have typically obtained their Shares through the exercise of stock options or by receipt of restricted stock grants.
What securities are they selling?
Most sales are of Common Stock, though there have been some sales of Preferred Stock. Some Issuers have two classes of Common Stock – a class with super-voting rights and a plain vanilla class of Common Stock. In such cases, the vanilla class is invariably the security being sold. All such shares are typically deemed to be ‘restricted securities’ under applicable Federal and state securities laws.
Additional Hurdles to Effecting a Purchase and Sale: ROFR’s and Co-Sale Rights
In addition to the outright prohibition on Transfers, most Restricted Stock Purchase Agreements or Option Exercise Agreements include provisions granting a “Right of First Refusal” (a “ROFR”) under which the Issuer (or its designee), within a prescribed period of time after receipt of a Transfer Notice, may elect to purchase the Shares on substantially the same terms as those proposed in the Transfer Notice.
In some instances, particularly where the Shares to be transferred consist of Preferred Stock, other early stage investors in the Issuer may also have ROFR’s and/or Co-Sale rights entitling them to also sell Shares along with the Seller.
The exercise of any of these rights by the Issuer or another stockholder effectively derails the purchase by the Buyer.
Virtually all ROFR and Co-Sale provisions provide that, in the event the rights are NOT exercised, the Seller has a fixed number of days in which to complete the Transfer to the Buyer. In the event the transaction is not completed within the allotted time, any subsequent attempt at Transfer must once again pass through the ROFR and/or Co-Sale process.
Effecting the Purchase and Sale: The Stock Transfer Agreement
The core document for effecting the purchase and sale of the Shares is the “Stock Transfer Agreement” (also sometimes called a “Stock Purchase Agreement”) (the “STA”).
The typical STA contains:
• The principal terms of the sale, i.e., number of Shares to be sold, price and the like
• Representations and warranties of the Seller include Title to Shares; Absence of any lien or encumbrance; Power and authority to sell.
• Representations, warranties and covenants of Buyer include Power and authority; Sale was not effected through any public advertising or general solicitation; Buyer is taking for investment intent; Buyer is sophisticated and has sufficient access to information
• Buyer absolves Seller for any liability due to the fact that Seller may have superior information regarding the Issuer Buyer agrees to be bound by same restrictions as were applicable to the Shares in the hands of the Seller
Closing Mechanics
Assuming the ROFR is not exercised, the parties may proceed to a closing. Generally speaking, the Seller and Buyer execute and deliver the STA to the Issuer for its approval.
Seller delivers Stock Certificates to the Issuer or its Transfer Agent.
(Some Issuers actually require that all Stock Certificates be held in escrow by Issuer’s counsel to facilitate transfer in the event of a ROFR exercise. In that case, the other parties will only receive photocopies of the certificates.)
Once approved, a virtual closing is conducted, with the Purchase Price being wired by the Buyer to the Seller and the STA signatures and the opinion of Seller’s counsel being released to the parties. Subsequently, the Issuer issues a new Stock Certificate in the name of the Buyer.
About Mitchell C. Littman, Esq.
Mitchell Littman is a founding partner of Littman Krooks LLP and heads the firm’s corporate and securities department. His practice includes public and private offerings, broker-dealer and investment banking matters, secondary market transactions, venture and private equity capital investments and mergers and acquisitions
About Wedbush Securities Private Shares Group
The Private Shares Group of Wedbush Securities covers the growing base of privately traded securities, with an emphasis on those in the social media space. The mandate of the group is to build our trading network in all private shares, source deal flow in the space (including “initial private offerings”), and to build funds and create other alternative investment opportunities across private shares for our institutional and accredited retail clients.
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