Who would imagine that you could, with the magic of the Internet and from the comfort of your living room, sell or buy shares of later stage private companies that you hear about over the Internet (or for some on TV or in old fashioned newspapers or magazines)? Companies like Groupon, Twitter and Facebook come to mind.
For employees and other owners of promising young companies that are not yet public (or possibly may never be publicly-held), these new online “markets” are a potential source of liquidity. Some companies even encourage, or certainly don’t discourage, the use of these online sources of cash since most companies have the first right to buy back the shares (or stock options) before the employees may sell the securities to outsiders. This sort of private party trading is not revolutionary as federal and state securities laws have established a basic regulatory scheme for such trading, and regulators like the U.S. Securities and Exchange Commission (SEC) recognize that it is important that such trading be allowed for many reasons.
In the “old days,” a company representative or outside agent would keep track of those interested in buying or selling and would connect the parties. If the introduced parties agree on price and terms, the company would recognize the transaction and issue new stock certificates accordingly. No public offering. No publicity. No general advertisement. No general solicitation. No big deal.
The combination of fewer public offerings and a depressed mergers and acquisition market in 2009 and 2010 resulted, however, in companies, owners, employees and stock watchers turning to the Internet to provide a better and faster way to facilitate trading. Online “bulletin boards” now allow immediate and 24/7 access for sellers and buyers of interests in private companies. Even those holding only stock options have turned to these Web sites for ready access to cash. If you have not already, just review the SharesPost or SecondMarket sites and you will immediately recognize the apparent convenience and attractiveness.
For SEC regulators and securities lawyers, these “passive” bulletin boards are not without complexity and potential headaches. The recent Facebook-Goldman embarrassment raised many of the same issues that these online bulletin boards raise. Are these truly private transactions? When there is publicity regarding the offering, when there is no or limited prior relationship between the parties, when there is a virtually unlimited opportunity for potential buyers to view (and potentially bid on) securities being offering, and when the trading is subject to no regulatory oversight, can an argument be made that these online markets simply provide companies and their owners and employees access to cash without the hassle and cost of a registered public offering? Are companies participating at least in part so that cash resources can be used for purposes other than stock repurchases? Are others allowing this trading to take place because they are waiting for a better time to start a public offering process?
To be sure, there are substantial benefits to such trading, and the SEC has for some time provided guidance so that private trading may occur without formal registration under the securities laws. The legal disclaimers and other rules of engagement posted at these Web sites are consistent with the prior SEC guidance, including:
• No compensation or commission is paid to the company hosting the information;
• No recommendation to either buy or sell is provided;
• No direct involvement in any negotiations between a buyer and a seller; and
• No monies are received, held or distributed by or through the hosting company.
There will likely be continued interest in alternative means to convert equity into cash for high growth companies and their owners and employees. This should not be a surprise as the formal registration process with the SEC is expensive, unpredictable and distractive (not to mention the cost and regulatory challenges once publicly-held). Finally, do not be surprised if the SEC becomes more active and proposes some additional guidance and restrictions on Internet-based trading vehicles and related activity.
Joseph E. DeGroff is a partner in Ice Miller's Business Group and was a founding partner of Ice Miller's Private Equity and Ventures Services. DeGroff's primary areas of practice include venture finance transactions, general business laws matters, federal and state securities law, and mergers and acquisitions. If you have questions about Internet-based trading activity, you can contact DeGroff at (317) 236-2435 or firstname.lastname@example.org.
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.
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