Twitter and Square stemming secondary trading?

Along with LivingSocial, startups aren't particularly thrilled about thriving private company deals

The secondary market party might be getting a tad too out of control.

LivingSocial, Twitter and Square, three of the hottest tech companies to emerge in the last few years, are each seeking to prevent their newest shareholders from selling company stock on the secondary markets, according to several people close to the dealings (via Bloomberg).

All three mentioned companies declined to comment.

SecondMarket, one of the organizations that mediates secondary market trading, reported that it completed $268 million in private company stock transactions for the first half of 2011, marking a 75 percent year-over-year increase versus the first half of 2010. In that period, volume totaled $153 million.

Not coincidentally, Twitter and LivingSocial are the second and tenth most watched companies on SecondMarket.

And, as if we needed more proof of the growing urge to sell private company stock: SharesPost, another secondary market, actually ranked as the third most popular “rising star” on SecondMarket’s list of companies with the fastest-growing number of watchers.

Why private company employees and other shareholders might want to sell their stock is obvious enough: liquidity is nice. But--and this is less obvious--the companies having their stock shuffled around pre-IPO see the trading as an unnecessary distraction.

As a result, sources say Twitter asked investors in its most recent round, rumored to total $800 million and led by DST, to avoid secondary sales. Appearing to oppose the deals even more intensely, LivingSocial and Square are said to be writing the restrictions directly into their contracts.

The (so far unconfirmed) maneuvers perfectly align with what Jeff Bloom, partner at Fenwick & West LLP, argued would happen to secondary trading. Bloom, speaking on a panel at Venture Shift, answered in the affirmative when the moderator asked whether the venture capital industry would fight back against the secondary market.

Secondary investors may not really understand the risks involved in their new investments and, even worse, the secondary trading does little to help still-private companies succeed.