“So if you can’t take a company public, how do you get out?”

Asks Fred Wilson.  Fred contends that the IPO market has been languid since 2000 and to sustain the current pace of innovation financing, VCs need a new route to exit their investments. M&A have lost momentum. The acquisitions by Google (YouTube, Feedburner), Microsoft (Facebook), AOL (Takoda) and Yahoo (Del.icio.us, Flickr) have flailed post acquisition.  Soon this window too will be shut.

So Fred suggests a new path to liquidity.  I quote –

This topic came up in the comments to my Decline of the Firm post and one thing that was mentioned is Goldman Sachs’s GS True market. As my friend Roger Ehrenberg (author of the awesome Information Arbitrage blog) explains on Seeking Alpha:

But now there is a new game in town, and it relates to IPOs: Goldman Sachs’ (GS) GSTrUE (“GS Tradable Unregistered Equity OTC Market”) program.

It turns out that there is another private liquidity market under development called Opus-5.

The idea behind both of these new emerging (and currently illiquid) markets is to provide a place for private equity investors to trade securities with each other. The companies remain private, do not have to file with the SEC, and do not trade daily like public stocks do. When an entrepreneur or investor wants liquidity on a position they own, they come to these private markets, offer their position or part of their position for sale, and a trade is made.”  (Hat Tip : Narain)

Huh, is that so simple?  I see some basic flaws in such private exchanges.

a) Signals despair : Private exchanges have no market makers; and hence no two way quotes. The very fact that a VC investor is putting up his stake for sale declares (a) the investment has turned bad; or (b) the investor is in a hurry to exit. There is only an `ask’ and without a counter `bid’, VC has bared all her cards. Out goes her bargaining power.

b) Disillusions founders: Founders look up to VCs to provide them strategic support, connections and mentoring. If VC stakes change many hands, the founders lose orientation and may even stray. They feel they’ve been taken for granted.

c) Tax treatment of Income : Trading thro private exchanges meant for a special category of investors like VCs will make them ineligible for concessional tax treatments (capital gains / business income) available to traders in public markets. Proceeds from such divestments may get treated as windfall / speculative income – that could suffer far higher rate of tax.

d) Cartel plays : It is possible for a group of high networth investors to get together and indulge in price manipulation or badger a VC into submission. All they need to do is quote their bids in unison with a time stamp. Take it or leave it.

A better way I think, is [to let VCs like Fred not have post-selloff remorse] is “stock warehousing”. VCs can found a platform with high networth investors and build a fund that offers liquidity in lieu of stock placements, with a promise to take them back at a later date at a pre-determined price. Just have a neutral body for valuations. VCs get liquidity, they don’t forego control and the business is run as usual.




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