
How Wall Street Middlemen Help Silicon Valley Employees Cash in Early - zachb
http://www.wsj.com/article_email/how-wall-street-middlemen-help-silicon-valley-employees-cash-in-early-1427474284-lMyQjAxMTE1NjI0OTIyNjkyWj
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ScottBurson
So this is where Sarbanes-Oxley has gotten us: to where it's so painful to run
a public company that companies put off their IPO much longer than they would
have, so people figure out how to trade the stocks anyway -- but in doing
that, they have to go on far less information than they would have had, pre-
Sarbanes-Oxley, when the company would already be public.

The law of unintended consequences is alive and well.

~~~
paul
On the other hand, the .com bubble was driven in large part by the ability of
VCs to flip junk onto naive retail investors.

The fact that venture investors now need to wait many years for an exit (and
the startups can really only access institutional capital during that time)
helps keep things a lot more grounded in my opinion (though I'm sure many will
disagree).

~~~
gfodor
Don't worry, the SEC will eventually fully open the doors to retail investors
investing in private equity. Imagine the bubble when the companies don't even
have to disclose the bad news!

~~~
paul
Yeah, I'm not convinced that's a good idea, but I think they are at least
putting some extra limits in place so that they won't gamble their whole 401k
away.

~~~
gfodor
They say Americans learn about geography though war -- I'm going to say they
learn about economics through financial crises. Most people don't understand
private equity markets (like they didn't understand CDS's, etc) so it's
certainly in the list of contenders for the next crisis.

~~~
davmre
I'd wager most people don't understand CDS's even now.

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sohailprasad
I'm the CEO of Equidate, one of the companies profiled in this article.

The article raises excellent points on the pitfalls of trading pre-IPO stock
on secondary markets. The opportunity is risky to be sure, only for educated
investors as ready and able to lose money as to make money. Information is
limited and protections are only as good as the integrity of the participants.
That puts a premium on honestly, transparency, and strict adherence to
securities regulations.

The American economy is built on liquidity and rapid turn-around of
investments: new company founders, investors, even venture capitalists and
private equity fund managers got where they are because an early exit allowed
them to cash in early gains in order to re-invest in the market. This used to
take a few years, but now, due to market changes, they will no longer see a
penny until their company goes public after an average 7.5-year wait. More
likely, their company will fail despite years of hard work and success,
leaving them nothing. Secondary markets are a relief valve for these founders,
early angel investors, and current and former employees.

When shares cannot be traded, even the most ambitious and brilliant
entrepreneurs are locked in for the better part of a decade, waiting for
something to happen. If they have liquidity they can start something new —
perhaps a cure to disease, a new media company, or one that launches rocket
ships. This liquidity is how many of today’s great companies got their start.

Collectively, we owe it to founders and investors, and the economy, to create
reliable secondary markets. That’s why Equidate was founded.

~~~
pthreads
"Collectively, we owe it to founders and investors, and the economy, to create
reliable secondary markets. That’s why Equidate was founded."

No we don't! There are no reliable secondary markets and there is not going to
be one simply because they are based on pure speculation. It exists for one
reason only - shareholders of pre-IPO companies don't want to wait years and
hence are willing to trade their shares for immediate cash.

Secondary markets are just another way to create derivates. And we all know
how unregulated derivates turned out!

~~~
sohailprasad
"It exists for one reason only - shareholders of pre-IPO companies don't want
to wait years and hence are willing to trade their shares for immediate cash."

Yes, secondary markets are designed to provide liquidity to shareholders in
pre-IPO companies. At the same time, most investors who want access to pre-IPO
stocks have no ability to participate. Value creation has increasingly shifted
from the public markets toward private markets. Consider eBay, which was
valued at $32 million in 1996 and went public with a $1.9 billion valuation in
1998 (a 60x gain), compared to Twitter which went public in 2013 at a $24
billion valuation, a 657x gain from their $35 million valuation in 2007.

Why should those who are extremely wealthy and well connected be the only
investors with access to such investments?

~~~
maaku
Because you cherry-picked the examples and chose not to mention the vast
majority of companies who's value went to zero?

~~~
sroussey
Indeed, if one could pick so well, then the public market is a great place and
more liquid.

------
chollida1
I think if anything, this type of arrangement will only increase.

it won't be long until this gets securitized so you can buy a basket of pre-
ipo stocks that are at the mezzanine level of funding.

Employee's get to take a bit of risk off of the table, investors get to buy
into pre-ipo stocks.

As long as we can create a suitable vehicle to get around the share holder
limit, and I'm pretty sure this is a well researched area, I can't see how
this doesn't become another securitized product.

If the alternatives are private secondary markets or employee's being locked
up util the company chooses to go public then this seems like a clear win.

This fixes one of the biggest problem with valuing startups. Right now startup
valuations are high because, just like free agent sports stars, you only need
one person to cut you a check for the valuation you want. Meaning, even if
everyone else thinks you are extremely over priced you still get the
valuation/money due to the one rogue investor/owner. This has the effect of
pushing valuation only upward.

Imagine an ETF that pools shares in pre ipo stocks. Now you can take the
positions that the unicorns are over priced and short them. This should give
us much better insight into what the entire market thinks these startups are
worth.

 __EDIT __as pointed out, companies may change their option plans to counter
this, I disagree that this will happen in a meaningful way. I think the good
companies to work for won 't and the bad companies will be left with the
choice of hiring only people who can't get better jobs or following along.

30 years ago stock options for everyone wasn't common. 10 years ago, perks
like free food weren't that common. Eventually if people are hard to find,
companies come around.

You could be right that this will never fly, but I'm betting on the good
companies dragging the rest of them along.

~~~
mblevin
That would be great - but companies are going to be exercising right of first
refusal and changing option plans left and right long before that happens.

Actual price transparency (with low volume that will further distort the
differences) for thumbsuck, pie-in-the-sky valuations in an overheated market
has only a major downside for founders and investors.

Remember your incentive stock option plan can be changed on a whim by your
"stock plan administrator" (e.g. the founders and investors).

~~~
dlubarov
I don't know how legally sound it is, but the article quotes Kenneth saying
"You’re not selling the shares, so the right of first refusal doesn’t apply".

~~~
SeoxyS
Hey, I'm the Kenneth quoted. The quote was taken out of context, but what I
was referring to is that in this scenario, you're trading a derivative and not
the actual share. You're entering into a private contract with the buyer
where, in exchange for a set amount of money, you're obligated to hold on to X
shares of the stock, to liquidate the position as soon as legally possible
during an IPO or acquisition, and to give him the proceeds. It's similar to an
option on the public markets, but without the exercising bit. The buyer does
not at any point own any actual shares, and does not end up on the company's
cap table. Because no share changes hands, the right of first refusal doesn't
apply.

This is good for the buyer, because he is guaranteed to be able to complete
the transaction. This is good for the company because they don't have to
choose between two annoying options: spending capital repurchasing the stock
at a price set by an outsider, or having to deal with a new investor on their
cap table with full information rights and counting towards their SEC investor
limit.

~~~
dlubarov
I understand how the deal is structured, but selling your interest in some
shares seems only superficially different from selling the shares directly.
Perhaps the employer could argue that you're effectively selling shares and
the ROFR clause applies?

I don't know, just speculating. Might not matter in practice if the employer
doesn't have that much interest in exercising their ROFR anyway.

------
philipn
This is really interesting, because in many cases these employees go many,
many without being able to sell any of their stock. One thing stuck out to me,
though:

"Terms of the deal call for Mr. Ballenegger to pay back the money if
Chartboost goes public or is sold"

So if the company is acquired for less than the valuation made when he
established the transaction with the derivative seller, he'd be up shit creek,
no?

~~~
SeoxyS
Hey - I'm "Mr. Ballenegger." (Coincidentally, that reporter found me through
an HN comment where I explained how secondaries worked.)

Derivatives like this are typically structured as a sale of the economic
interest, not a loan. In this scenario, if the company sells or IPOs, the
terms call for me to liquidate my position as soon as possible and transfer
the proceeds to the buyer. If the sale is not a positive outcome for the
investor, I have no liability.

I think this could probably have been worded much better in the article.

------
SeoxyS
I'm Kenneth Ballenegger -- mentioned in the article. I have some personal
experience with secondary transactions. Happy to answer any questions on the
topic, here or via email (address is on my profile).

------
davidu
The result of this small cottage industry is that employers will be tightening
up their shareholder agreements and their stock transfer restriction clauses.

~~~
npkarnik
In some cases maybe, but hopefully most founders who obtain some personal
liquidity in later rounds are not sadistic/hypocritical enough to deny their
employees the same opportunity.

But you're right, one potential large risk is a Chris Sacca -like situation,
where one investor/investment group uses many anonymous buying agents to
acquire a huge stake in a takeout/IPO candidate, via secondary liquidity. That
can mess up a final outcome for whoever thought they had control over the cap
table.

~~~
corford
Based on a comment further up, my understanding is people buying on the
secondary markets are not actually buying the shares. They're just offering $X
to an employee now in return for being entitled to the full sale price of that
employee's shares ($Y) immediately after IPO. $Y could be higher or lower than
$X (that's the agents risk) but at no time does the agent actually own the
shares.

~~~
gyardley
People buying on secondary markets often directly buy shares. They only resort
to derivatives when they're unable to buy directly due to stock restrictions.

~~~
corford
Aren't most pre-IPO shares restricted though (company has ROFR, company board
can block sale of shares to a third party they don't like etc.)?

~~~
gyardley
Yes, but the type of restriction matters. Sometimes it's just a ROFR at the
same price, and that alone isn't enough to deter either buyers or sellers from
directly buying and selling.

------
bsder
Um, good.

Things like lockout provisions are bullshit meant to provide a benefit for
insiders. In addition, founders and early investors can often "cash out" some
of their shares to another investor while the rank and file never get that
chance.

Anything which provides added liquidity to the little guys is good.

------
beachstartup
what this tells me is:

1\. for employees, startups are a lottery where an ipo is no longer a
prerequisite for winning

2\. for the rich and well connected, there exists an entirely separate and
privileged market for startup equity.

3\. the world isn't a fair place and complaining about it doesn't help. be
luckier or do your own startup if you want more money.

------
soldergenie
What happens in a market downturn and people suddenly holding private shares
worth a lot less than what they paid for? Then, you have lawsuits from these
holders claiming they didn't understand the risks of what they were investing
in (e.g.: no financials statements, etc) and these schemes will start coming
under the same regulatory scrutiny as public companies.

~~~
ojbyrne
2 words: "accredited investors." 2 more words: "no recourse."

~~~
q2
As long as this industry exposure is low, bubble bursts may not impact main
stream economy but if the exposure is more, then as previous financial crisis
shows,---due to inter linkages in finance sector and due to wrong judgments of
even supposedly sophisticated investors,--- main stream economy cannot live
insulated life.

So as of now, risk may be limited to investors in question only but if the
scope and invested money increases, then it can create fresh financial crisis
worldwide.

------
f00sion
Does anybody have first hand experience with Equidate or EquityZen? Been
thinking about this for the past few days and would be interested to hear any
personal stories.

~~~
sohailprasad
Given the nature of secondary transactions, many people don't want to talk
publicly about their experience. That said, if you're interested in working
with us, I can make introductions to a couple shareholders or investors that
have worked with us in the past (and have agreed to share their story).

I'm also always happy to chat and answer any of your questions. Feel free to
email me: sohail at equidateinc dot com

------
jameshart
Wouldn't it be more efficient in this case to have the startup sell share
options directly to the investment market, and use the funds to pay their
employees?

This model of paying employees in options, then having traders offer to
liquidate those for cash, puts risk on the person who can least afford it out
of the three parties involved - the employee.

~~~
foobarqux
But then they would need to deal with SEC regulations.

------
mattmanser
Why are you hiding behind an anon account to post this?

~~~
dang
This was in reply to
[https://news.ycombinator.com/item?id=9299916](https://news.ycombinator.com/item?id=9299916),
but we've detached it as off-topic.

