Tuesday, January 24, 2012

Done right, emergent private exchanges can strengthen the IPO marketplace. "Done right" is the key

Read another interesting article, describing a recent talk, that brings up some issues worth a second look. The speaker and subject of the posting is a very smart entrepreneur who knows a great deal about markets, both public and private.  The piece covers private share trading, growth businesses for the last couple of years, as investors have scrambled for early access to shares of high-profile companies like Groupon, Zynga and Facebook among others.

From the combination of early employees seeking pre-IPO liquidity and later stage investors wanting to own shares of a few particular companies at pre-IPO prices, emerged an opportunity for a couple of savvy entities that built sophisticated eBay like mechanisms for trading private stock.  The strong IPO pricing and aftermarket performance LinkedIn were all it took to convince plenty of qualified investors to line up for a chance to participate in the private company markets; investors ranging from well to do individuals to some of the country's largest mutual and hedge funds.

The good news is that the success of these emergent trading platforms demonstrates that investors are clearly willing to try new markets, even ones that come with the disadvantage of much less transparency.  Investors in public stocks at least have quarterly financial releases to help them determine if the investment thesis is on track.  They also have a liquid market in which to sell their stock if they perceive that things aren't going as hoped.  Conversely, investors in private securities generally have significantly less information and the rather important disadvantage, at least for now, of tremendously reduced liquidity versus public markets.  If something goes wrong, selling a block of private stock can be on par with selling a house in central Florida in 2009, except that with real estate, (assuming one covered the mortgage payments) the seller with an unwanted property still has the house. With private equity, if the investment company hits a serious speed bump, the seller can be left with a worthless piece of paper. Period.

Recently, seeking the potential extra reward, investors have shown a willingness to absorb that incremental risk.  Or at least they did last year.  2012 could be a different story.  Plenty of private investors did well in early 2011. Their success stories proved to be a siren call, attracting new private investors in search of similar success.  But as with all markets, the private market news was all good until it wasn't.  "Wasn't" became tangible with Groupon and Zynga. These well-known companies with hotly anticipated public offerings, sold shares in the private market  at prices higher than their subsequent IPO value.  In the aftermarket, at least as of January 2012, these companies continue to trade below some of their former private market prices. The late-stage, private market bets on these "high fliers" failed to pay off.  Too many more of these and the private markets will likely have a very difficult time attracting new investors.  While both Zynga and Groupon may pay off splendidly in the coming years, there was no reward for those who jumped in on the late side of early.

Astonishingly, the recently posted article about these markets suggests that when companies trade at higher prices in the information-limited private markets and then perform poorly in the transparent, public market, it is an indication, at least according to our high-profile speaker, that "the IPO market is dying".  Really?  That a large pool of investors pays less for a company when they have data to analyze when compared to what a small contingent paid when they were trading on blind faith and betting on a greater fool theory, indicates that the educated market doesn't work?  In what alternative universe? 

There is definitely a place in the world for emerging private market trading mechanisms done right, and they can be a very useful mezzanine step while companies mature toward prime time readiness.  However, it is nonsensical to suggest that the existence of a new private market has dire consequences for the public marketplace. The IPO market is alive, well, healthy and thankfully much more selective than it was during the drunken era 12-15 years ago.   While that's rough on the relative performance of today's private investors, such rationality bodes well for all investors, public and private over the long run.  Darwin's commentary on survival applies far beyond the animal kingdom. 

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