This article was originally published by Jeron Paul, founder of Capshare (now Shareworks by Morgan Stanley).
I would like to look at the evidence and recent developments that indicate a significant amount of convergence between public and private markets and then speculate on just how far it will go. In this first part, I will talk about this history of private and public market separation and the current evidence for convergence.
Today, I would like to talk about public and private market convergence–a fascinating topic to me personally and an important one for our team at
I suppose we could start with a fundamental question: Why are private markets and public markets separate and different in the first place? On the face of it, and as one who has passed the Series 7 test (“passing” in this sense could also be synonymous with “passing” a kidney stone), it would seem that the obvious reason for the separation is because of government regulation enacted to protect against fraud. Back in the 1930s the government enacted a series of laws designed to protect against fraud. States began to enact “blue sky” laws the prohibited fraudsters from selling speculative interests in fake endeavors whose assets were no more tangible than “several feet of blue sky.” This led to more organized laws at the national level and the creation of the SEC. These laws essentially create major obstacles to any kind of mass sales of stock. However, the government didn’t want to shut down the obviously benefits of being able to sell securities to the public for non-fraudulent companies, so they created a highly regulated process which allowed companies to solicit funding from the public in certain cases.
While this may be the easy answer, I personally think that the real answer is more nuanced. There are pros and cons to being able to solicit publicly. There are pros and cons to being able to solicit privately. Public market registration is very costly, complicated, highly regulated, and now somewhat fraught with personal liability risk if you are an executive (due to Sarbanes-Oxley compliance for example). However, there is still no better source of major liquidity for early shareholders and ongoing liquidity for current shareholders. Also the wisdom of crowds creates an always up-to-date valuation for shares based on a government-mandated continuous flow of publicly available financial information from the company.
Private market share sales are by comparison relatively inexpensive, fast, and easy but 1) sales are typically restricted to “accredited investors,” 2) companies are not required to publicly share information, and because of 1 and 2, 3) there is no easy way to come to a valuation of the company in question. All of this spells ILLIQUIDITY. As it always does illiquidity = risk BUT illiquidity also = opportunity. You could argue that the entire venture capital and angel capital industry started out with a simple realization: “hey somebody could make it slightly easier to raise money for legitimate start up companies and possibly make a killing.”
Now fast forward to the present. For a variety of reasons we are seeing a significant convergence between public and private markets. Here is the evidence:
- The US passes the Jumpstart Our Business Startups (JOBS) Act of 2012, which provides for general solicitation of funds for emerging growth companies and crowdfunding ( )
- Public Markets are essentially shutting down all non-electronic trading and are generally financially struggling ( )
- SharesPost, one of the most prominent private share exchange sites, sells to NASDAQ ( )
- AngelList gets significant traction as a portal where angels can invest in startups ( )
- brings all of the same equity management tools to the private markets that are available to public companies, most notably electronic capitalization tables
- The venture capital industry is democratizing and increasingly seeking the wisdom of crowds: AngelList, Quirky ( ) , a good friend and investor Gavin Christensen at Kickstart recently started this ( ), crowdfunding sites like Kisckstarter ( ) , and IndieGoGo ( ) have been going crazy.
Let’s highlight a few features from the JOBS Act:
- Title I essentially amends the two primary acts that separate private and public companies (the Securities Act of 1933 and Securities Exchange Act of 1934) to make exceptions for “Emerging Growth Companies.” These are basically all companies with less than $1B in revenue and which have raised less than $1B in capital. Yeah, you heard that right. That is basically 95%+ of ALL companies. And this is already law.
- Title II is HUGE. It basically completely removes the prohibition against the general solicitation of money from the public for private companies PROVIDED THAT although private companies can SOLICIT money from virtually anybody they can only ACCEPT money from accredited investors. And this is already law.
- Title III adds that not only can companies solicit money from the public for their equity but they can ACCEPT money even from non-accredited investors provided that it happens according to certain rules. This is called “crowdfunding.” The rules for this have not yet been approved by the SEC, so in many ways we are on hold here.
- Title VI basically expands the limitation on the number of shareholders a company can have before going public from 300 to 2000.
These exceptions essentially free these companies from much of the cost and complexity of filing to go public while still allowing them to generally solicit funding in exchange for shares. They demarcate a clear interim step between private solicitation and public solicitation.
In the next post, I will discuss the future:
- Will total convergence happen?
- Will companies be able to “go public” without going public? In other words, does “crowdfunding” just become a synonym for “going public.”
- Information concerns and assymetries and their implications,
Would love to hear your thoughts! If you want something to back up my experience: check out my LinkedIn profile (). In short I went Harvard Business School, founded a company later acquired by Thomson Reuters (
) , worked in VC for 5 years ( ), started a secondary investment fund (Stockbridge Equity Partners), founded and sold a private company valuation firm ( ) and most recently founded Capshare, now .