The Allure of Private Financing

In connection with the recent announcements of Facebook and Groupon raising significant capital in private secondary markets, I participated in the following CNBC interview on the topic.  

Private financings are typically done under Regulation D, which provides for an exemption for certain private placement transactions from the public registration requirements.  This is the typical financing exemption for most capital raising activities from VCs, private equity firms, or other sophisticated investors.  This regulation allows an unlimited amount of capital to be raised from sophisticated investors, with the backdrop that a private company can only have up to 500 shareholders of record, otherwise it will be required to become a publicly registered company.  In the event a company trips the 500 shareholder limit, it has to become a reporting company (file 10-Qs and 10-Ks) within 120 days after the end of the fiscal year where the limit was exceeded. 

Many shareholders are also utilizing secondary market platforms, such as SecondMarket or Sharespost to sell shares in private transactions, principally to obtain liquidity.  Many of the hottest start-ups are seeing increased activity on these secondary platforms.  While these platforms can provide a limited amount of liquidity for some shareholders, companies are putting more restrictions on these types of transactions.  Why?  Concerns over inflated private valuations, lack of control over the number of shareholders of record, and control over shareholder ownership.  If your stock is traded at a $2B valuation in the private markets, it may mean that any stock granted to a new employee you hire must valued at those levels.  That could limit your ability to recruit motivated technologists in the valley if your stock has already run to the top.  Regulators are also concerned about the policy implications of rising trading in the private markets.  Concerns over disclosure, transparency of information, shareholder limitations, etc. are the biggest issues. 

While we will likely continue to see growth in the technology enabled private platforms, the advantages of being a public company are still very real.  Permanent access to capital, access to institutional and retail investors, access to the largest pools of liquidity, full and transparent information, and visibility and branding drive most companies to this strategic decision.  Most see these benefits far outweighing the costs of being public; but the tension between those two has never been higher, as the costs of being public are still too high.