Goldman’s Facebook deal strikes blow to private-stock market

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The SEC’s regulatory interest in the market in private-company shares might cripple this source of funding.

It looks as if Goldman Sachs’s $450 million investment in Facebook might put the kibosh on the growing market in trading private company stock. As reported in Euromoney’s December issue (Private stock markets – an alternative to IPOs), growth companies, particularly those in the social media sector, are increasingly delaying their IPOs and turning for liquidity to direct investments or private-stock trading platforms, such as SharesPost or SecondMarket. Now the hefty investment by the public’s most disliked investment bank into the social media darling has sparked an investigation by the SEC into pooled investment funds in pre-IPO stock.

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The key query by the SEC seems to be whether private firms’ stock is held by more than 499 shareholders. If that is the case, firms, even though private, are subject to certain financial disclosures. The question is: is an investment fund to be counted as one shareholder? Or should the underlying shareholders be counted separately?

One would hope that the high-profile investment in Facebook might open the door to similar investments for other growth firms. However, for smaller and medium-sized companies, the deal is more likely to spell disaster. Having been forced out of the IPO market by the consolidation of investment banks that would be willing to cover them and because of Sarbanes-Oxley compliance costs, being able to release privately owned stock to raise money had become an increasingly attractive alternative for these companies.

Many CFOs of small or mid-sized companies also lament that going public is like rolling dice these days as shareholders are no longer long-term investors but more often day traders.

The secondary private market had offered some relief and was growing in popularity. SecondMarket, for example, formally launched its private-stock trading platform in April 2009 and at the beginning of December had about 25,000 buyers and sellers, with more than $400 million in transaction volume in 2010. Back then Facebook shares were trading at about $18. One can guess that price has increased since the Goldman Sachs injection.

If the regulatory spotlight on the private company market leads to more onerous reporting or administration for the secondary trading platforms and/or small direct investors, small and mid-sized growth companies in the US will find themselves with even fewer options for survival. Let’s hope the SEC treads gently.