Conglomerate Blog: Business, Law, Economics & Society

In Business Associations, I try to drive home the message that shares in a closely-held corporation are theoretically freely transferable, but in practice not so much. The market is illiquid, and finding others to purchase your shares, particularly if they reflect a minority interest, will not be easy. As an outsider, it's hard to value the shares. In addition, the most assured route to receiving an return on investment of minority common shares is either through discretionary dividends or possibly through employment at the corporation, leaving the outside investor uneasy. But what if you could overcome these obstacles -- a market that connects buyers and sellers, provides market-based valuation, and signals the potential of an eventual liquidation event?

Sharespost.com is apparently a website that attempts to connect sellers and buyers of unregistered shares in private corporations. These are shares that would be owned by founders, employees, perhaps angel investors? Note, however, that these are share in venture-backed corporations, not in your family business. So, the venture-backed nature sends a signal to the market not only of value, but also of potential exit. This website, in fact, is mentioned in a Recorder article on Facebook shares.

Sound perfect, but what are the concerns? My first thought was securities law. The article says "Companies such as Sharespost.com and Secondmarket.com have sprouted up in the past two years, following an SEC rule change that relaxed restrictions on selling shares of private companies." OK, but the SEC hasn't promulgated any safe harbor that says any person can sell any shares to any other person at any time. Looking on the SharesPost.com website's "Legal" page:

Though each participant in a SharesPost facilitated contract is solely responsible for making their own legal determination about the availability of an exemption from the securities laws, we believe we have constructed the SharesPost process such that Buyer and Seller can generally make use of a Section 4(1) exemption, and in some cases, Rule 144. Supporting such an exemption is the fact that only SharesPost members with a password protected account are able to participate in postings, only accredited investors can be SharesPost Buyers, and only sellers holding their shares for at least a year can be SharesPost Sellers.

First, I think SharesPost means that most will qualify for the safe harbor in Rule 144, and in some cases the more restrictive original 4(1) exemption. The three requirements listed seem focused both on meeting holding periods in Rule 144 and ensuring that this is not a public distribution but a resale to specific buyers who can fend for themselves under 4(1) (or 4(1 1/2), in securities professor jargon).

So who is really concerned? Issuers. First, resales can threaten to bring the number of shareholders to over 500, triggering full-fledged registration requirements under 12(g) of the Securities Exchange Act. Second, issuers seem to be worried about insider trading problems, prompting Facebook to ban their employees from selling shares on SharesPost.com except during certain windows. Facebook may be trying to control a different problem than insider trading, however. (In fact, having the company set windows for trading seems to raise more insider questions than not.) Issuers may be worried about 12(g). They may be worried that whatever exemption they used to issue the shares will be busted by an untimely resale. They may also be worried about feeding a secondary market that may be too incomplete to give good information or even a little too complete. Private issuers don't have to tell the market as a whole how well they are doing day-to-day. An incomplete market can mess up going public plans (like Facebook's rumored plans) by inadequately reflecting that private information so as to send a lower, incorrect pricing signal. Or, premature negative inside information may make the market a little too complete when an issuer would prefer opacity.

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In Business Associations, I try to drive home the message that shares in a closely-held corporation are theoretically freely transferable, but in practice not so much. The market is illiquid, and finding others to purchase your shares, particularly if they reflect a minority interest, will not be easy. As an outsider, it's hard to value the shares. In addition, the most assured route to receiving an return on investment of minority common shares is either through discretionary dividends or possibly through employment at the corporation, leaving the outside investor uneasy. But what if you could overcome these obstacles -- a market that connects buyers and sellers, provides market-based valuation, and signals the potential of an eventual liquidation event?

Sharespost.com is apparently a website that attempts to connect sellers and buyers of unregistered shares in private corporations. These are shares that would be owned by founders, employees, perhaps angel investors? Note, however, that these are share in venture-backed corporations, not in your family business. So, the venture-backed nature sends a signal to the market not only of value, but also of potential exit. This website, in fact, is mentioned in a Recorder article on Facebook shares.

Sound perfect, but what are the concerns? My first thought was securities law. The article says "Companies such as Sharespost.com and Secondmarket.com have sprouted up in the past two years, following an SEC rule change that relaxed restrictions on selling shares of private companies." OK, but the SEC hasn't promulgated any safe harbor that says any person can sell any shares to any other person at any time. Looking on the SharesPost.com website's "Legal" page:

Though each participant in a SharesPost facilitated contract is solely responsible for making their own legal determination about the availability of an exemption from the securities laws, we believe we have constructed the SharesPost process such that Buyer and Seller can generally make use of a Section 4(1) exemption, and in some cases, Rule 144. Supporting such an exemption is the fact that only SharesPost members with a password protected account are able to participate in postings, only accredited investors can be SharesPost Buyers, and only sellers holding their shares for at least a year can be SharesPost Sellers.

First, I think SharesPost means that most will qualify for the safe harbor in Rule 144, and in some cases the more restrictive original 4(1) exemption. The three requirements listed seem focused both on meeting holding periods in Rule 144 and ensuring that this is not a public distribution but a resale to specific buyers who can fend for themselves under 4(1) (or 4(1 1/2), in securities professor jargon).

So who is really concerned? Issuers. First, resales can threaten to bring the number of shareholders to over 500, triggering full-fledged registration requirements under 12(g) of the Securities Exchange Act. Second, issuers seem to be worried about insider trading problems, prompting Facebook to ban their employees from selling shares on SharesPost.com except during certain windows. Facebook may be trying to control a different problem than insider trading, however. (In fact, having the company set windows for trading seems to raise more insider questions than not.) Issuers may be worried about 12(g). They may be worried that whatever exemption they used to issue the shares will be busted by an untimely resale. They may also be worried about feeding a secondary market that may be too incomplete to give good information or even a little too complete. Private issuers don't have to tell the market as a whole how well they are doing day-to-day. An incomplete market can mess up going public plans (like Facebook's rumored plans) by inadequately reflecting that private information so as to send a lower, incorrect pricing signal. Or, premature negative inside information may make the market a little too complete when an issuer would prefer opacity.

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