Bring On The Social Media Bubble: SharesPost Inflates Pre-IPO Valuations

BubbleThat bubble’s gonna pop!

Photo: tlindenbaum

Want to buy a piece of the social networking site LinkedIn, which many expect will debut as one of the hottest IPOs of 2011?How about the coupon website Groupon, which recently spurned a $6 bn buyout offer from Google? Or perhaps you’d like to own a stake in Facebook, the most hyped tech start-up out there? 

You won’t find shares for any of these red-hot companies listed on the traditional home of American tech stocks, the NASDAQ. But you can find them with valuations that seem to fly higher every day on an obscure secondary exchange called SharesPost, which caters to pre-qualified private investors and company insiders looking to unload pre-IPO shares in their companies.

The San Bruno, California-based company launched in 2009 and now lists more than 100 companies, most of which are venture-backed, pre-IPO stage start-ups in areas like technology, clean tech and social media. In recent months, some of the hottest companies – including Facebook, LinkedIn, Twitter and Groupon – have also seen their shares soar as a small number of investors hash out values with limited knowledge of underlying company financials, as anticipation toward eventual IPOs grow.

Back in April 2009, LinkedIn was valued at $1.9 bn; today it has an implied value of $2.2 bn. Facebook was valued at $16 bn as recently as last spring. Last week, investors led by Goldman Sachs forked over $2 bn for a 1 per cent stake that now gives the company an implied value of $50 bn.

SharesPost ‘was founded to address the lack of market liquidity for private company shares and to modernize a transaction process for secondary market securities that hadn’t changed in close to a century,’ says Dave Weir, CEO of SharesPost. Since launching, the company has experienced ‘significant growth as the interest in investing in pre-IPO companies like Facebook, LinkedIn and Twitter has reached an all-time high’.

‘In less than two years,’ Weir continues, ‘we have added close to 50,000 registered members representing more than $125 bn in managed capital, and today we have more than $1 bn in posts to buy and sell in our online marketplace.’

Although anyone holding shares in a listed private company can sell them, to buy shares on a secondary site a buyer must be an accredited investor, which the 1933 US Securities Act defines as someone with a net worth of at least $1 mn, or someone who has made $200,000 each year for the last two years.

The growth of secondary exchanges like SharesPost has exploded in recent years as the US regulatory landscape tightened in the wake of the corporate scandals of the early 2000s, says University of Illinois law professor Larry Ribstein, an expert in corporate and securities law. That has led a number of companies to delay going public.

‘It’s related to the costs of being public and going public, which continue to go up,’ Ribstein explains. ‘First there was SOX and then Dodd-Frank and now also an increasing cost imposed by shareholder governance in publicly owned corporations.’

Ribstein notes that the migration to private placement is depriving ordinary investors of the opportunity to reap the benefits of investing in a start-up company early. ‘A few years ago, in the early 1980s, you could have bought into Microsoft in an early phase,’ he points out. ‘If Microsoft were going public today, I think like Facebook it would think twice.

‘It’s pretty clear that once Facebook goes public, it will be as a more mature corporation than when Microsoft went public, which reduces the ability of the ordinary investor to share in the extraordinary profits.’

Justin Byers, an analyst at VC, which provides research reports based on the limited regulatory filings available for non-public companies, notes that with regard to the firms listed on SharesPost there’s ‘a lot speculation and subjectivity that is going to go into valuations unless you have the numbers right there in front of you.’

Restated articles of incorporation and other obscure public filings can provide some clues as to appropriate company valuations. As the company remains private, however, financials are often unavailable.

Given the current valuation of Facebook, ‘you have to think – a good bit of it is going to be hype because people just want to own a piece of the company,’ says Byers. ‘Then again, these are supposed to be accredited investors, so you have to hope they are doing their due diligence.’

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