Quick Take: TN VCs comment on Private-Company Exchanges

By Milt Capps

Published February 11, 2010

Comment

Liquidity is where you find it.

Some Tennessee VCs say they see merit in the exit options provided by a batch of new private-company exchanges, including Portal Alliance and Second Market.

In a Jan. 25 report, Pensions & Investments' (P&I) Arlene Jacobius reported, in part, "PORTAL Alliance and other private-company exchanges came to the fore in 2007 when Apollo Global Management and Oaktree Capital Management LP listed on investment bank-run private exchanges including Goldman Sach's GS True. Industry insiders were hoping the new exchanges would become a viable exit option for private equity and venture capital firms' portfolio companies as well, especially now that firms are keeping companies much longer than they had planned... But the banks' platforms had few issuers. For example, GSTrue currently has just two issuers, Apollo Global and Oaktree Capital..."

Asked for his comment, Memphis-based Jan Bouten (left), a partner in Innova Memphis, told VNC, "Companies like Facebook have allowed some of its shareholders to liquidate their shares in places like SharesPost and Secondmarket. In today’s environment, where VCs push for mega-exits, they often forget about the impact this has on the founders and early employees of a company. Facebook could have exited at probably $50M, $200M, $1B and $5B, but the investors wanted more," he said.

Bouten continued, "For the founders, each exit event would have been a life-altering event, but they had to extend their risk period because of investor pressure. So it’s only fair to allow the employees to cash out part of their stock early."

Said Bouten, "The problem with any of these secondary markets is that they only work for companies that are doing really well: companies that can continue to raise money at increasing valuations. In today’s market, however, most startups have trouble raising money, even at flat or lower valuations. So it’s unlikely they can sell stock on a secondary open market. As a result, if VCs want to sell stock in such a market, I’d stop and think “Why are they selling?”

Jim Phillips (right), partner, Pharos Capital Group in Nashville, offered: "While these exchanges are interesting in concept, I

think the lack of any volume is really representative of the issues they face. If a current company shareholder or insider does not want to purchase a position, it is hard to find an outside third party at a clearing price even setting aside the problems of a right of first refusal for a sale. They have been modestly more successful for LP interests. In addition SharesPost has an interesting model for founding employees' stock, where they are able to diversify and find some liquidity, pre-IPO."

Rob Ivy (left), administrative partner and CFO at Salix Ventures here, told VNC this morning he thinks the private-company exchange is "not a bad concept, but I think it will take some time to get traction. Venture and private equity firms need liquidity options, and with IPO and debt markets tight, a private exchange makes a lot of sense. However, I think most institutional investors will take a wait-and-see approach. I doubt many portfolio companies would want to be the guinea pig. There are risks - for example, if a company lists on the exchange and there's no demand for its shares, that could certainly impact valuation in a traditional sales process down the road."

Also responding to our query, Nashville-based Claritas Capital's John Chadwick told VNC he thinks that – along with the higher returns Venture investing has generally been regarded as producing – the new exchanges could help offset the downside of Venture, i.e., "the long hold periods and the associated illiquidity." ♦