Exchanges for private shares grow more popular

With the IPO market stuck in the slow lane, it will soon become routine for private companies and their backers to generate liquidity by selling shares to other private investors.

That, at least, is the vision behind three private exchange startups launched in the past year, each with a business plan structured around facilitating deal-making between late stage companies and private investors. So far, however, the upstart exchanges haven’t had a discernable effect in alleviating the liquidity dry spell for late stage venture- and private equity-backed companies.

That will soon change, predict the founders of companies focused on private share sales.

Speaking at last week’s AlwaysOn conference at Stanford University in Palo Alto, Calif., founders of SharesPost, SecondMarket and InsideVenture said they have collectively signed up more than 200 companies to participate in their respective efforts to link liquidity-hungry later stage companies with accredited private investors.

Companies that aspire to be publicly traded, they say, are increasingly looking at shorter-term liquidity options, as the time span from initial funding to an IPO increases. The median age of a VC-backed company that went public last year was 9.6 years, up from 4.5 years in 1998, according to the National Venture Capital Association.

“There’s been this acceptance that private companies will stay private longer, so there has to be some development in the capital markets to address that fact,” said Barry Silbert, CEO of New York-based SecondMarket. The company operates an exchange for illiquid assets, such as mortgage-backed securities and collateralized debt obligations, and added a marketplace for private company shares earlier this year.

Silbert said SecondMarket has signed up a dozen companies so far, including Facebook, and he anticipates adding another 15 in the next few weeks. He added that he is in discussions with another “hundred or so” companies. Silbert estimates that about $200 million in private shares are currently for sale on Secondmarket, which is used by an estimated 950 qualified investors.

Mona DeFrawi, CEO of Menlo Park, Calif.-based InsideVenture, which focuses on deals between pre-IPO companies and buy-and-hold oriented institutional investors, said her firm is currently in discussion “with a couple dozen companies” looking to participate in a newly launched product called a hybrid private-public offering (HPPO).

HPPOs (pronounced “hippos”) are investment agreements between a pre-IPO company and an institutional investor that agrees to invest in a later stage private round and a subsequent public offering. DeFrawi did not disclose the names of the companies that InsideVenture is working with, but she said that she plans in the next few weeks to name some companies that have secured investments and are prepping for IPOs.

SharesPost, based in Santa Monica, Calif., launched its site for connecting private share sellers and buyers in late June. Founder and CEO Greg Brogger said he is targeting companies with sales between $100 million and $500 million a year. The goal, he said, is to attract companies that are fairly established and successful, but do not consider it beneficial to go public in the current market.

SharesPost maintains bulletin board listings for about 200 later stage private companies and has signed up several thousand users, according to Brogger. Venture-backed companies listed on the SharesPost website include Facebook, eHarmony, Linden Lab, LinkedIn, Slide, SolarCity, SugarCRM, Tesla Motors and Twitter.

In addition to listing share prices, the site provides implied valuations for companies if buyers consummate a purchase. For example, in the listing for dating site eHarmony, 3,000 shares recently sold for $8 each, giving the company an implied valuation of $353 million. Other sellers last week were asking between $10 and $15.25 a share for blocks of stock, giving eHarmony an implied valuation ranging from $441 million and $673 million.

Given that all three private exchange startups have been involved in the sale of company shares for less than a year, it remains unclear what level of buyer interest will develop.

“This market environment is different than anything we’ve ever seen,” says Will Ray, managing director at WebIMC, an investment advisory firm. “And valuation is tricky.”

An obvious problem is that because so few companies in emerging industries have launched IPOs recently, it’s difficult to find public market comparables to use in setting valuations.

SharesPost has responded to the valuation issue by publishing analyst reports that lay out valuation estimates. For eHarmony, the site links to a report from NextUp!, the research firm founded by SharesPost board member and former ThinkEquity CEO Michael Moe.

The report says that eHarmony currently has more than 3 million active members, more than $200 million in annual revenue, and that its appropriate market capitalization should be between $764 million and $820 million.