The State of SecondMarket

Updated: March 14, 2011

We're used to hearing about the stock market, but lately, there's been a lot more buzz about SecondMarket. The service acts as a sort of trading platform for assets that aren't on public stock markets like NASDAQ or Dow Jones, and has generated a ton of interest among investors. Although SecondMarket is barely seven years old, its presence is being felt by mainstream investors more and more with each passing day.

What Is SecondMarket?

SecondMarket is, very simply, "the marketplace for alternative investments." Founded in 2004 (and originally called Restricted Stock Partners), SecondMarket allows accredited investors to buy and sell not just private company stock but also a wide range of other assets, including:

  • Auction rate securities
  • Bankruptcy claims
  • Collateralized debt obligations
  • Mortgage backed securities
  • Limited partnership interests
  • Whole loans

In a relatively short time, SecondMarket has become the leading secondary market for swapping shares of privately traded businesses. It enables founders to profit from their ownership interests prior to (or instead of) IPO and lets investors get their hands on assets they would've otherwise had no opportunity to buy.

SecondMarket vs. The Public Markets

A February 2011 CNBC article illustrates the impact that SecondMarket is starting to have on the public stock markets. For one thing, by providing an alternate way to liquidate company ownership, it is apparently making private companies more reluctant to go public:

CEO Barry Silbert told us 'there's a confluence of events making it less attractive for private companies to go public.' This trend, according to Silbert, began over 10 years ago. First, Silbert said "the cost and requirements to go public is increasing making it difficult to be a small company getting attention on Wall Street...Then you 'had the introduction of Sarbanes-Oxley."

Silbert also believes that the public markets have evolved to favor traders, citing how the average investor now holds on to stocks for just 2.8 months. In total, high frequency traders account for 60% of public stock market trading. Thus, because "the public market more and more caters to traders and does not favor investors", more companies are opting for stability - and avoiding the IPO.

A Growing Phenomenon

Moreover, SecondMarket shows no signs of slowing down. If anything, interest in and demand for the unique trading platform is sharply rising. Per CNBC, there were an average of $862 worth of monthly trades on SecondMarket in 2010 - and the total dollar amount of trades soared from $2.2 billion in 2009 to $10.3 billion in 2010. In September, the company made the Inc, 500 list of the fastest-growing private companies in America. "This prestigious honor follows SecondMarket's recent selection by the World Economic Forum as a 2011 Technology Pioneer, an award presented to the most innovative technology start-ups from around the world", according to SecondMarket's official website.

What SecondMarket Activity Tells Us

Above all, SecondMarket tells us that entrepreneurs are not passively waiting around for the IPO market to revive itself. In a blog post for AVC.com, Union Square Ventures principal Fred Wilson says:

Entrepreneurs won't start companies and investors won't invest in them if there is no path to liquidity on the company stock. A secondary market for private company stock can fill the gap that the lack of an I.P.O. market has created.

However, SecondMarket also gives investors a rough proxy of valuation on companies that eventually will IPO. Facebook is a case in point. In February 2011, TechCrunch reported that the company was trading at $27.00 per share - good for a $67.5 billion valuation. During the final months of 2010, CNBC estimated that "something like 12%" of Facebook's privately held stock was in play on SecondMarket. Increasingly, valuations on SecondMarket and similar platforms could begin to influence actual IPO performances on the public stock markets.

Potential Conflicts

As with all new and unproven investment platforms, SecondMarket has attracted scrutiny from regulators. On February 23, MarketWatch reported that the Securities Exchange Commission was "looking into whether conflicts of interest are occurring in the unregulated market for shares of private companies." The main problem, from a regulatory standpoint, appears to be the lack of transparency on SecondMarket relative to the public exchanges. When investors buy up shares of private companies like Facebook and Twitter - "often at sharp valuations" - they do so without having access to the financials of those companies. The SEC is also concerned that "a number of the market-making firms" are not registered as broker-dealers and should be, although SecondMarket was not named specifically.

How To Participate

Whether you wish to participate in SecondMarket as a buyer or a seller, the signup process is virtually identical. The company offers a 60 second signup form that immediately asks which one you're signing up as. (You can sign up as both a buyer and a seller, if you wish.) The only caveat is that you must meet the Securities Exchange Commission's definitions of an "accredited investor", qualified purchaser or qualified institutional investor - meaning that your income and investment holdings must fall within certain guidelines (discussed at the link above.)

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