NVCA Today

A thriving secondary market for private company stock was finally established in 2009 . . . and it arose at exactly the right time. With an anemic IPO market and the lowest number of M&A deals this century, 2009 was the year that secondary sales in late stage VC-backed companies surged. In the fourth quarter alone, over $75 million in private company stock was traded on SecondMarket across a broad array of VC-backed companies including Facebook, Twitter, Tesla, LinkedIn and Zynga.

The lack of a functioning IPO market and minimal M&A activity have left investors in early stage companies with few options for liquidity in these investments. Systemic problems facing companies wanting to go public, including lack of research, Sarbanes-Oxley requirements, etc., compound the problem of an IPO as an exit strategy. In 2007, the last year with more than a handful of IPOs, The median age of a venture-backed company from founding date to IPO hit a 27 year high in 2007 at 8.6 years.¹ As the 5- and 10-year returns for VC firms continue to decline, investors began to increasingly turn towards the private markets.

As a result, the secondary market for VC-backed companies has never been more active, and given these structural changes to the public equity markets, it is expected to remain a permanent part of the capital formation process. With household names like Facebook trading well above the valuations of previous rounds², investors are increasingly looking to a new set of buyers beyond strategics and public equity investors. Recent data from SecondMarket³ shows a strong demand for not only consumer internet companies, but also clean tech and other industries. While public offerings for the strongest private companies now have a real possibility of occurring in 2010, the timing for specific companies is still highly debatable.

In addition to changing market structures, the increasing number of late-stage investors allowing existing shareholders to take money off the table during primary rounds is fueling the growth of the secondary market. Recent examples include Digital Sky Technologies’ investments in Facebook and Zynga, as well as Elevation Partners’ investment in Yelp. The "knock-on" effect of these transactions is an increased demand for liquidity from shareholders who do not participate in the initial round. These types of transactions also set a floor for the price of a given company's stock, which give outside investors the confidence to transact with limited information.

As fund raising continues to be challenging, VCs who raised funds at the beginning of the century are starting to feel strong pressure from LPs to return capital now rather than wait any longer for a "traditional" exit. The 2000 vintage year funds have distributed only 47% of the paid-in-capital (DPI) and the residual value is only 47% (RVPI) for a total-value-to-paid-in-capital (TVPI) of 0.93.⁴ The fact that these funds have not broken even adds to an already challenging fund raising environment due to the economic downturn.

One of the leading questions among VCs is how secondary transactions affect 409a valuations and the ability of their portfolio companies to offer low-priced options to their employees. So far, the actuaries have maintained that secondary sales are just one data point into the 409a valuation process along with public comparables, discounted cash flow (DCF) analysis, etc. The circumstances surrounding a secondary transaction, including the seller’s motivation and buyer’s strategic intentions, are contributing to discount the effect of the transaction on 409a pricing, resulting in smaller than excepted impact on a company’s option pricing.

As the secondary market for shares in VC-backed companies continues to grow and more VCs look to sell positions to new investors, there will continue to be new issues that will impact the venture capital industry. The NVCA has announced an agreement to collaborate with SecondMarket on a number of initiatives. By working together, the NVCA and SecondMarket will continue to develop this new path to liquidity, which will enhance the exit environment for venture-backed companies and their investors. SecondMarket is offering NVCA members a 20% discount on transactions under $5M and a 25% discount on transactions over $5M.

For more information on SecondMarket’s Private Company Market, please contact:

Adam Oliveri
Managing Director, Private Company Market
This e-mail address is being protected from spambots. You need JavaScript enabled to view it
212-668-3035
www.secondmarket.com/markets/private-company-stock.html

1. http://nvca.org/index.php?option=com_docman&task=doc_download&gid=287&Itemid=314
2. SecondMarket data and http://online.wsj.com/article/SB124750449551533697.html
3. http://techcrunch.com/2010/02/08/facebook-tesla-and-solyndra-dominate-secondmarket-transactions-in-january/
4. http://www.nvca.org/index.php?option=com_docman&task=doc_download&gid=551&Itemid=314