Awesome look at an emerging niche sector in the finance community and startup ecosystem.

It's pretty clear that there is and should be healthy demand on a low-volume basis. I think the real question being discussed is what the macro longterm impact is. Frankly, there is no reason why private company securities can't be traded in the same way as public company ones. I don't think the secret information issue is a real problem.

The companies that have the most traded stocks will have the ability to draw additional funds out of the investment community, esp in emergency situations. They will grow faster and be more resilient. Their competitors will follow suit.

Keep in mind that most public company SEC filings fail to provide adequate information given the scope, size, and complexities of modern corporations.

A different perspective on this issue is that there is actually low demand for any kind of security, public or private, issued by these companies as evidenced by a lack of a strong IPO market.

Ultimately, lower transaction costs increase the size of secondary and follow-on investment markets for angel and VC backed startups. Being a professional angel becomes easier as paper work and match-making costs are eliminated. Perhaps this trend could turn into a bubble as there are significant amounts of people with this kind of money.

Wow! That's quite an in-depth take Michael. I agree about the lack of transparency in SEC filings. The intent of the complex disclosure requirements is at odds with what's become a "check a box" approach. With tons of boxes, you end up with 250 page registration statements hardly anyone reads and another 200 to 600 pages of Exhibits that a person has to spend weeks analyzing to put into a context. It's sad that this information (on public companies) is not approachable by anyone (it's not complicated stuff if presented properly). But when the important SEC filing information (items needed to easily determine cash flow potential and, therefore, value) is surrounded by explanatory notes that require a degree in law or accounting, everyone has to either rely on analysts to make a decision or just take a chance based on herd or gut instinct.

I'm not sure that the opacity of many publicly traded offerings is going to comfort many investors looking for information on private securities, but I agree SharesPost is serving a valuable market function especially for shareholder liquidity. Individual investors willing to take the risks may be relatively few and playing a rich man's game, but there would seem to be an opportunity for institutional investors with knowledge of the companies they are buying, and perhaps even specialized mutual funds?

I'm curious what SharesPost's rules are in serving as a market maker for these securities? Is that spelled out in their terms and conditions somewhere?

Great points Gary (as always). I agree. I don't know that Sharespost is a "market maker" per se (they don't perform the function of a specialist or a broker dealer at this point). However, based on my understanding, they provide an infrastructure that cost effectively addresses the barriers to engaging in these types of transactions. You can register for free on their site, and you'll notice that there are a collection of legal forms as well as relationships with parties (US Bank) needed to clear transactions safely http://www.sharespost.com/pages/legal

As far as institutional investors versus high-net worth individuals, I also agree that it's a rich person's game. However, statistics show that a very large percentage of individuals participate in this area (as angels and as members of loosely organized investing groups). Like many high-growth deals, the risk of losing 100% of the capital invested often exceeds the probability of realizing the investment multiples required to justify such an investment. It's possible, I believe, for an offering such as Sharespost to provide access to an investment stage (post series A/B, post marque VC lead investor, pre-IPO) to get in to high growth investments at a different stage of the risk profile. That could help diversify their holdings of this particular class of investments (alternative assets) and therefore improve their outcomes. However, only time will tell if that opinion (just my personal theory) is accurate.

Lorenzo, thanks much, I appreciate it. I didn't intend to imply that SharesPost IS acting as a market maker (although I see how my post could be read that way), I was more wondering about the potential for them, or anyone else for that matter, to function in that capacity. Also wondering about the securities regulations for anyone to put together a mutual fund of such securities to spread risks?

Lorenzo, it is great you bring up the risk profile issue. From talking with people that might fit the profile of person to engage these services I've run into a common trend: people don't trust public company stocks anymore. I think there is room to create a strong investment thesis stating that there is an attractive risk profile when you are investing in private company stocks where there are trust worthy / skilled / experienced founders and managers who have not yet made it big enough to be able to defraud people in a way that would ruin their future opportunities. Why not invest in 3 guys from MIT with a $1.5MM Series A behind their belts?

Michael, that’s very interesting. I think you are implicitly referring to two different (but related) types of risks. One would be the risk of fraud, which you might say is ultimately a quality of earnings issue and the other is the risk of a variation in returns compared to the “risk free rate” (lots of ways to measure, but an easy one to understand and test is the Sharpes ratio). In periods of great liquidity for early stage companies, one could argue that the risk of fraud is comparable to what it is for public companies (it’s a matter of how many people are involve, how much money is involved and what’s really important to the participants and society). Remember when the metrics of page views, users and visits first became proxies for valuation back in the mid 1990s? I can assure you from personal experience across a wide range of companies during that time that those statistics, which were driving financial decisions (investment decisions), were often massaged to say the least in order to justify higher valuations. With an IPO within just a few years of starting a realistic objective, and peers that may have made millions in months at “lesser” companies, the lines between marketing puffery and securities fraud can start to blur.
“Fifteen million dollars is not money. It's a motive with a universal adaptor on it.”
That being said, I personally agree that investing in “3 guys from MIT” should outperform most indexes, assuming you can make enough bets (50 to 100) and there’s a source of capital to finance later stage growth and liquidity (which brings you back to some kind of public marketplace ultimately).

Gary, that’s a timely suggestion and question. As you may recall, there were several VCs (some of them quite successful and famous, such as Draper Fisher Jurvetson) that attempted to make venture type returns accessible to retail investors by way of a publicly traded vehicle (similar to a mutual fund). One of the reasons your comment is timely is that Congress just backed down off a new proposed reporting requirement for venture funds. A major issue for turning a venture fund into a public entity is how do you measure net asset value (NAV) for a class of securities that are so uncertain for most of their early lives? This change in unrealized value would account for most of the initial “earnings” of any fund. To put those challenges into perspective, think Enron. Historically, VCs have tried to be conservative with respect to value, which is a safer bet. Until relatively recent accounting rules (the same rules blamed in part for the volatility of earnings at Ford, Lehman and so-forth), VCs kept their investments at cost unless something really bad happened or something really good happened. Another challenge involves how do you keep certain strategic information private and still comply with the disclosure and financial reporting requirements of a publicly traded company? That being said, I’ve always believed there’s a place for such a model (a mutual fund for high-growth early stage bets), but haven’t really seen it executed successfully on a large scale in our country. An easier alternative, I believe, might be to simply have debt issues (zero coupon venture bonds) priced to deliver a comparable return to what people look for a alternative assets to return (14% per year or so)?