Private Company Secondary Markets

Facebook and Twitter are just the beginning

@cardinalrose

Table of Contents

Market Overview

Deal Mechanics

Completing a TransactionCompleting a Transaction

Appendix

Private Company Secondary Markets

Private company secondary markets will solve the liquidity problems for employees and board members while also providing inexpensive access to growth capitalinexpensive access to growth capital

Private Company Secondary Markets

“Late stage venture funds are like the small cap funds of the ‘90s and the early 2000s.” Lawrence Lenihan, Jr, FirstMark Capital, April 2011

My Prediction

Secondary markets institutionalize changing the industry:

• Many more companies adopt secondary marketplace platforms

• SEC introduces regulation that strengthens the market

• Late stage market expands and IPOs get pushed out further

• Stronger companies emerge as a result of longer gestation period

• Secondary marketplaces experience rapid growth replacing antiquated systems

The lines blur between late stage venture funds and hedge fundsThe lines blur between late stage venture funds and hedge funds

• Late stage funds reduce lockups from 10 years to 2 years to adjust for liquidity

• Hedge funds allocate 10-30% to less liquid secondary markets

•Balanced with market neutral public markets

• Massive amounts of capital flow into this new asset class

The IPO – Pros & Cons

Pros:

• Gain liquidity for shareholders

• Gain access to growth capital

Cons:

• Sarbanes Oxley

• Headaches, regulation & compliance

• Additional legal risks

• Wall Street disconnect

• Short term trader mentality

• Algorithmic trading disconnected from fundamentals

• Loss of cache

The Public Markets – Drivers of Change:

• Sarbanes Oxley

• Decimalization

• Separation of investment banking and research

• Consolidation of boutique banks

• Longer pre-IPO gestation periods

Current Late Stage Market Overview:

• There is ~$21b invested in late stage deals per year

• Traditionally 30-50 funds participate in this market

• Companies require inexpensive access to growth capitalcapital

• Companies require less board seat and operational advice

Ideal Private Secondary Market Company:

• $100-$500m in market cap

• $20m in revenues

• Approximately 5 years old

• Too small to go public

• Tech and Clean Tech sectors

• Don’t have to be profitable

• Venture backed

• Over 100 shareholders

Testimonials:

“These companies I’m buying on the private market are at the same stage as when I used to buy them when they went public. So why not buy them?” Business Insider, January 2011

“We now believe Facebook could be worth more than $200b in 2015” Wedbush, March 2011

The 4 Horsemen:

Company Date Funding Last Round Val Recent Rumored Val Revs 2011E P/S

Facebook Jan-11 $1.5b $50b $75b $4b 19x

Groupon Jan-11 $950m $4.8b $15b $2b 8x

Zynga Jun-10 $300m $4.5b $10b $2b 5x

Twitter Dec-10 $200m $3.7b $7b $140m 50x

Source: Company reports and Business Insider

Is There A Tech Bubble?

Blue chip techs are cheap

Expansion stage growth, similar to late stage

Completely ignored, no liquidity, getting worse

A handful are valuations are extreme, similar to mid capsLate Stage

Small Cap

Mid Cap

Large Cap

Valuations have crept up from $2-3m to $3-4m pre

Total VC AUM shrinkage decreases demand

Companies seeking $3m+ getting decent valuation

Seed Stage

Early Stage

Mid Stage

Changing VC Perceptions

Old:• No one exits before we exit

• A future exit keeps the employees motivated

New: New: • Employee liquidity helps retention & recruitment

• Secondary sales are a 3rd exit avenue after IPOs & M&A

• Can manage portfolio more efficiently

Private Markets are Institutionalizing:

2010: 90% of transactions were over-the-counter

2011: ~80% will be listed market transactions

• SecondMarket & Xpert Financial will be 100% listed

• SharesPost is registering as a broker-dealer• SharesPost is registering as a broker-dealer

• Primary markets will be established

What is a “Listed” Private Market?

• Company and board approved

• Controlled sales

• Limited Selling Windows• Limited Selling Windows

• Market Creation

• Right of First Refusal

Comparison:

SecondMarket• Launched April 2009

• Broker-Dealer

• Over $500m transacted

• Diverse Alt Assets

• 28 Reported Companies

• 2010: OTC

• 2011: Listed

• VC: FirstMark

SharesPost• Online Bulletin Board

• 3rd Party Research

• Registered Specialists

• 60,000 Members

• 16,000 Accredited

• Min Transaction: $25k

• Standardized Contracts

• Heavy Technology

Xpert Financial• 2 Years Old

• Broker-Dealer & SEC Reg ATS

• Tim Draper- Chairman

• Licensed Nov 2010

• Electronic Platforms

• Full Level II Quotes

• 8-9 Cos in Pipeline

• RegD Rule 506 –Primary Share

Sale License• Pursuing BD License

• 2-5% fee both sides

Sale License

• Rule 144A – Qualified

Institutional Buyers

• Rule 144 – Accredited investors

- non-Affiliated sellers - pending

• Reverse Inquiry Basis

• Company approval

Notable Secondary Transactions:

Kleiner Perkins $38m in Facebook at $52b, Feb 2011

Andreesen Horowitz $80m in Twitter, Feb 2011

DST indirect secondary participant: Facebook,

Zynga, Groupon

Accel sold $516m Facebook to TCV (~$200m), Andreesen Horowitz (~$80) and others at $35b, Nov 2010

Chris Sacca $400m in Twitter at $4.5b from Spark,

Union Square, and Ev Williams, Feb 2011

Deal Mechanics

3 Parties in a Secondary Transaction:

• Buyer

• Seller

• Company• Company

- Right of First Refusal

- Co-Sale Rights

Types of Buyers:

• Existing VC Investors

• VC Funds that lost primary round

• Fund-less Sponsors/Special Purpose Vehicles

• Participants in Secondary Markets

• Endowments, Pension Funds, HNW, Sovereign Wealth, Insurance, Private Equity

• Direct Secondary Funds

• Late Stage Venture Funds

• Mutual Funds & Hedge Funds - Public Market Investors

Types of Sellers:

40%

50%

60%

70%

80%

90%

100%

1Q10

2Q10

3Q10

0%

10%

20%

30%

40%

Ex-Employees Employees Investors/Other

3Q10

4Q10

Source: SecondMarket

Types of Secondary Sales:

• Sr. Preferred – indirect for Common Shares

• Jr. Preferred – indirect for Common Shares

• Outright purchase of Common or Preferred

• Upside Sharing – buyer splits proceeds of future sale• Upside Sharing – buyer splits proceeds of future sale

• Escrowed Shares – earn-out incentive

• Loan for Shares – avoids ROFR, Co-Sale & Taxes

• Loan to Exercise Options

Types of Transactions:

• Modified Dutch Auction

•Minimum bid, clearing price => lowest bid that clears

• Fixed Price Auction

•Set price, all bids above minimum

• Bulletin Board• Bulletin Board

•Bidders are matched to sellers online

Considerations:

Transfer Restrictions

• Right of First Refusal (ROFR)

• Co-Sale

• Upfront waiver rights can be granted

Workarounds

• Loan for Shares avoids ROFR and Co-Sale• Loan for Shares avoids ROFR and Co-Sale

• Earn-outs deter Co-Sales

Contractual Rights

• Registration rights and preemptive rights are transferrable

• Require separate transfer agreement with the company

Risks:

Two Primary SEC Regulatory Risks:

Special Purpose Vehicles designed to bypass the 500 investor rule

• Goldman Sachs’ US Facebook SPV was canceled

• Could give rise to parallel market of SPV

• Small SPVs charging 8% fees & 20% carried interest

•Shares post has completed 5 SPV auctions

•3% commission, 5% management fee, 3% distribution fee

•Cannot exit until IPO when Units convert to FB shares•Cannot exit until IPO when Units convert to FB shares

Lack of Share Count, Cap Table, and Company Financials

• Even “sophisticated” investors need financials

• Significant amount of 3rd party data but little company data

• Listed markets resolve this issue

Additional Risks:

• Illiquidity

• Opacity

• Information Asymmetry

• Valuation

• Behavior of secondary investors

• Shift from options to RSUs

Future Listed Markets:

Companies will waive ROFR in exchange for:

• Employees sell no more than 10-15% of vested/owned positions

• Only employees with 4+ years can participate

Board approved potential investor list

• Investors adhere to the board’s guidelines• Investors adhere to the board’s guidelines

• Investor group receives audited financials

• Company has recourse if guidelines are violated

Completing the Transaction

Private Company Secondary Markets:

SharesPost example:

Current Active Trades on SharesPost:

SharesPost Order Entry:

SharesPost Order Confirmation:

SharesPost Bid/Ask Page:

Yelp! Company Registration:

NeXt Up Research: Yelp! Key Metrics:

NeXt Up Research: Yelp! Valuation:

NeXt Up Research: Yelp! Lead Investors:

Appendix

Companies Traded on SecondMarket:

Facebook Price Chart:

$30.00

$40.00

$50.00

$60.00

$70.00$33.00 4/1/2011

$33.00 4/1/2011

$35.00 3/29/2011

$35.00 3/17/2011

$33.00 3/11/2011

$33.00 3/11/2011

$37.00 2/18/2011

$30.00 2/14/2011

$31.00 2/11/2011

$31.00 2/7/2011

$32.50 2/3/2011

$35.00 2/2/2011

$35.00 2/2/2011

$35.00 1/26/2011

$35.00 1/19/2011

$60.00 1/19/2011

$50.00 1/13/2011

$46.00 1/12/2011

$45.00 1/12/2011

$50.00 1/11/2011

$55.00 1/11/2011

$50.00 1/11/2011

$55.00 1/11/2011

$35.00 1/10/2011

$40.00 1/7/2011

$55.00 1/6/2011

$25.00 11/30/2010

$25.00 11/24/2010

$20.00 11/22/2010

$15.20 11/9/2010

$20.00 11/4/2010

$15.20 11/2/2010

$25.00 10/19/2010

$0.00

$10.00

$20.00$51.00 1/19/2011

$40.00 1/19/2011

$27.60 1/19/2011

$60.00 1/18/2011

$40.00 1/18/2011

$45.00 1/18/2011

$50.00 1/17/2011

$45.00 1/16/2011

$50.00 1/15/2011

$45.00 1/14/2011

$48.00 1/14/2011

$66.00 1/13/2011

$25.00 10/19/2010

$14.40 8/31/2010

$15.00 8/31/2010

$15.00 8/30/2010

$15.00 8/10/2010

$15.20 8/5/2010

$12.00 7/27/2010

$14.00 6/25/2010

$13.50 6/24/2010

$12.60 6/21/2010

$10.00 4/26/2010

$5.40 12/4/2009

$2.40SharesPost

3rd Party Research:

• Wedbush Securities

• Liquid Scenarios

• VC Experts

• Research 2.0

• NextUp Research

• Arcstone Partners

• CB Insights

• Greencrest Capital

• Blueshift Research

• GigaOm

• Crystal Research Associates

• PrivCo

• Majestic/ITG

Largest VC Backed Deals in 2010:

1 Better Place Clean Tech Expansion $350,000,300

2 Twitter Internet Expansion $200,000,000

3 BrightSource Energy Clean Tech Later Stage $150,000,000

4 Abound Solar Clean Tech Expansion $111,000,000

5 Trilliant Telecommunications Later Stage $105,999,800

6 Elevance Renewable Sciences Clean Tech Expansion $100,000,000

7 HighTower Holdings Financial Services Expansion $99,999,900

8 Casa Systems Internet Infrastructure Later Stage $96,460,000

9 Pierpont Securities Financial Services Expansion $84,999,9009 Pierpont Securities Financial Services Expansion $84,999,900

10 Fisker Automotive Clean Tech Later Stage $78,078,900

IPO Pipeline:

Date Name Ticker Description IPO size 2010 Revs

7/14/2010 AMC Entertainment AMC Movie Theaters $450m $2417m

3/11/2011 HomeAway AWAY Online Real Estate Rentals $230m $168m

3/15/2011 Qihoo 360 QIHO Chinese Online Security $200m $58m

2/27/2011 LinkedIn Business Social Network $175m $161m 9 months

9/29/2009 NewEgg.com EGGZ Electronic Ecommerce $175m $2100m 2008

2/28/2011 Skullcandy SKUL Electronic Accessories $125m $140m estimated

11/9/2010 Tudou TUDO Chinese Online Video $120m $34m 9 months

2/11/2011 Pandora Online Music $100m $55m FYJan112/11/2011 Pandora Online Music $100m $55m FYJan11

8/9/2010 Skype Online Telephony $100m $406m 6 months

12/23/2010 Responsys MKTG Email Marketing $60m $85m

11/17/2010 Kayak KYAK Online Travel $50m $128m 9 months

2/10/2010 Gamefly GFLY Online Video Game Rentals $50m $98m FYMar10

Relevant 2010 IPOs:

Name Ticker Performance

Epocrates EPOC 44%

Demand Media DMD 24%

Neilson Holdings NLSN 17%

Sky-Mobi YSM -33%

Dangdang DANG 69%

Youku.com YOKU 174%

Bitauto BITA -26%

Mecox Lane MCOX -33%

MakeMyTrip MMYT 86%

GreenDot GDOT 20%GreenDot GDOT 20%

RealID RLD 49%

Tesla TSLA 31%

Vringo VRNG -41%

Motricity MOTR 55%

ReachLocal RLOC 59%

TeleNav TNAV 39%

Convio CNVO 32%

Quinstreet QNST 51%

Average 34%

VC Market in Graphs

The VC industry has lagged the major benchmarks over the past 10 years:

10 years

Dow Jones 2.50%

S&P 500 -0.40%S&P 500 -0.40%

Nasdaq -4.30%

US Venture Capital Index -4.60%Cambridge Associates, Sept 2010

Due to “J-Curve” older funds should have higher TVPI but they don’t:

0.8

1

1.2

1.4

Total Value to Paid in Capital (TVPI)

0

0.2

0.4

0.6

0.8

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Cambridge Associates, Sept 2010

As a result VC assets under management are falling:

$200,000

$250,000

$300,000

Assets Under Management

$0

$50,000

$100,000

$150,000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

NVCA, Jan 2011

And the total # of VC funds are falling:

1000

1200

1400

1600

1800

2000

Total # of VC Funds

0

200

400

600

800

1000

NVCA, Jan 2011

But the total # of investments is steady:

5000

6000

7000

8000

9000

Number of venture investments

0

1000

2000

3000

4000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

NVCA, Jan 2011

And the total amount invested is steady:

$80.00

$100.00

$120.00

Total Amount Invested

$0.00

$20.00

$40.00

$60.00

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

NVCA, Jan 2011

There have been so many deals but so few exits:

8%

10%

12%

14%

16%

Exits as a % of Total Deals

0%

2%

4%

6%

8%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

NVCA, Jan 2011

IPOs have dried up:

150

200

250

300

IPO exits

0

50

100

150

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

NVCA, Jan 2011

The median age at IPO has risen from 6 to 10 years:

6

8

10

12

Median Age at IPO

0

2

4

6

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

NVCA, Jan 2011

Private Secondary Markets are a new exit option:

$100,000,000

$120,000,000

$140,000,000

$160,000,000

$180,000,000

Transaction $ Amount

$0

$20,000,000

$40,000,000

$60,000,000

$80,000,000

1Q10 2Q10 3Q10 4Q10

SecondMarket, Feb 2011

What happens next?

Secondary markets institutionalize changing the industry:

• Many more companies adopt policies and platforms

• SEC introduces regulation that enhances the market

• IPOs get pushed out further and bypassed entirely in some instance

• Stronger companies emerge as a result of longer gestation period

The lines blur between late stage venture funds and hedge funds

• Late stage funds reduce lockups from 10 years to 2 years to adjust for liquidity

• Hedge funds allocate 20%-40% to less liquid secondary markets

•Balanced with market neutral public markets

• Massive amounts of capital flow into this new asset class

Thank You

Jason M. Jonesjjones@highstepcap.comjjones@highstepcap.com914-315-9751

Follow me on Twitter: @cardinalroseProfile on Google: /profiles.google.com/jjones1/