As the value of high-growth U.S. Internet companies such as Facebook soared, early investors and employees turned to free-for-all private markets to cash out.
Online marketplaces for trading shares in unlisted companies, such as New York-based Second Market, were akin to a Wild West in which private companies had no say in the price of their shares or who their shareholders were.
Things got so bad that U.S. companies started drafting constitutional documents (the equivalent of British Articles of Association) to block the activities of secondary markets.
Enter NASDAQ OMX Group, which hopes to make such marketplaces popular by giving companies control over who can trade their shares and help with cap-table management.
Today, on average, companies are waiting until they have much higher market caps to go public, meaning that stakes are locked in for a longer period. Facebook, for example, waited eight years before floating in February 2012. The IPO raised $16 billion, making it the third largest in U.S. history at the time, behind General Motors and Visa.
What Is A Secondary Market?
Secondary or private markets are marketplaces that allow angels, venture capitalists, private equity firms, founders or employees to trade shares in a private company. Since growth companies are waiting an average of eight to ten years before going public, there is a growing need to get liquidity other ways. First-generation secondary markets in the U.S. used to trade shares of private companies did not allow companies to control who was trading their shares.
“This is a different phenomenon than we had seen previously,” says NASDAQ chairman Bruce Aust. “This is why we launched NASDAQ Private Market, so these companies can have liquidity programs that will allow them to retain their employees without going public, but at the same time maintain control.
Helping start-ups sell shares and manage stock plans is part of NASDAQ’s strategy to cozy up to start-ups at an earlier stage, in the hope that more will choose its exchange. The move comes as NASDAQ faces increasing competition both at home and abroad.
The first company to sign up when NASDAQ Private Market (NPM) launched in March was Mobli, an Israeli social mobile photo and video-sharing site which competes with Instagram. The company raised $60 million last November from América Móvil, the telco giant led by Carlos Slim. The listing on NPM gives Mobli and other companies the option of conducting primary capital raises or controlled secondary transactions.
NPM Is Considering Launching In Europe
To trade on NPM in the U.S., companies have to meet at least one of a number of qualifications: they must have raised $30 million in funding within the last two years; total assets and annual revenue must each be $50 million or more; they must show an annual net income of $750,000; shareholder equity must be at least $5 million; and they have been operating for at least two years.
NPM is considering launching in Europe but would first need to secure regulatory approvals. As more European companies go for growth rather than selling early, unlocking some liquidity is likely to have some appeal.
“The ability to take a little bit of liquidity out is a good thing because it encourages the entrepreneur to go for a bigger exit,” says Nenad Marovac, a managing partner at London-based venture capital firm DN Capital.
Tips For Designing Effective Equity Plans
- The accounting treatment is different for different share awards, depending on whether they are cash settled or based on performance, so model accounting charges before deciding on the type of share plan.
- Consider how much information you will have to give employees if they are given the option to buy shares.
- Change shareholders’ agreement to allow a carve out. Articles in the agreement should have clear terms to enable employees to acquire shares but also sell them if they leave.
Even before NPM enters the market two private marketplaces have launched in the UK: Asset Match and Liquity.
“We are endeavoring to make it easier for private companies to raise money by providing a realistic exit route,” says Iain Baillie, Asset Match’s co-founder. “IPOs are statistically irrelevant as an exit and in trade sales everybody has to sell.”
Liquity plans to relaunch in January as a subscription service for investors who want to connect with people who want to confidentially sell stakes in private companies, says founder Barry Shrier.
An indication of interest in the space is that Asset Match was voted one of the fastest-growing companies in the UK in 2013 by Sir Terry Leahy and Lord Young as part of an ‘Accelerate 250’ program, while in July Liquity was chosen as a Top 10 finalist in Startupbootcamp’s 2014 Fintech accelerator.
NASDAQ believes it has several differentiators: to launch its own private market NASDAQ bought Sharespost, which like Second Market was active in selling the shares of Silicon Valley companies like Facebook, and has integrated the company’s technology.
Stock Plan Administration Is Not Rocket Science
NASDAQ has since made another acquisition, TruEquity, which offers an integrated stock plan administration and capitalization table tracking service for private companies. The service allows investors and founders at start-ups to understand who owns what as well as to run planning scenarios.
Stock plan administration “is not rocket science, but it is complicated,” says Eran Palmon, the Silicon Valley-based Israeli entrepreneur behind TruEquity, which NPM has renamed ExactEquity. “There are so many mistakes and misunderstandings. We wanted to make this data accessible so that everyone can understand what is going on.”
Roger Rappoport, an entrepreneur-turned-lawyer at Silicon Valley’s Procopio, Cory, Hargreaves & Savitch law firm, an active user of ExactEquity, says he recommends founders start their cap table/stock plan administration tracking from day one to ensure they understand how investment terms can impact their holdings and future exits.
At NOAH, a conference on November 13th-14th that focuses on late-stage Internet companies, Carine Schneider, the president of NPM, and Janet Cooper, a managing partner at Tapestry, a UK law firm focused on compliance, are hosting a workshop on how to implement equity plans.
It Is Not As Difficult As You Might Think
“We found that as we talk to founders in Europe and definitely in the UK that although the giving equity to employees philosophy sounds right — they get the Silicon Valley story — the tax and legal and currency issues here make it very difficult to use it the same way as the Americans do,” says Cooper. “But it is not as difficult as you might think.”
Taking the time to develop an equity plan for employees is worth it, she says. “Why do it? Companies tend to grow much quicker because it incentivizes the staff to work that much harder.”
What is important, says Cooper, is to not just give employees shares but grant them the opportunity to sell the shares. “Then people will see the value.”
If you look at it from that perspective, “the ability to trade on private markets in a controlled environment helps companies retain employees,” says Schneider, NPM’s President. It should also help to attract top talent.
As European companies go global and recruit internationally they will have to meet demand in markets like the U.S. and Israel for packages that include equity and offer employees not just shares or options but the ability to cash out without waiting eight to ten years for an IPO.