Nick O'Neill

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SecondMarket Is Screwing IPO Investors

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I spent the morning reading two posts from Fred Wilson and Chris Dixon on the state of technology IPOs. Both have accurately identified the current state of IPOs: companies are being accurately valued.

I think the main story here is that most of the people buying shares during the IPO roadshows aren’t getting the great deals they are hoping for (or used to). The most common play is to buy pre-IPO stock and then flip those shares the day they go public (or soon after) for a profit. That’s not happening though. Do investors deserve that pop? Probably not. In the previous bubble, the absence of a secondary market meant that it was easier for large price discrepancies to take place. In other words, they offered a price arbitrage opportunity.

But unfortunately that play isn’t available anymore as secondmarket is generating “fair” valuations through increased liquidity. The result is that many of the clients who were investing with Goldman and other banks are going to gradually shift their funds to large private market transactions or even late stage venture investments. Why would investors get involved during an IPO roadshow when the price isn’t going to pop? There’s no incentive.

While I don’t think Goldman’s clients are going to go running for the door, the signs are pretty clear: the secondary market is going to continue to explode. There’s one caveat: if Fred Wilson’s guess about private market valuations being higher than public market valuations is accurate (he states “I believe that some of these companies had private financings at our above these current market caps”), the signs actually suggest that there’s a bubble in late-stage investing.

You’d be better off purchasing shares after an IPO than on second market (unless you want bragging rights to say you own a hot private company’s shares). The one exception is companies like Facebook, which had years of secondary market transactions. Just two years ago, you could have bought Facebook shares at $20 billion and flipped it at an $80 billion valuation before an IPO even takes place. That also means people who are acquiring shares of Facebook right now at lofty valuations may actually end up not getting the reward they were expecting.

The upside: there are still plenty of ways to make money in this market (transaction fees/market making is clearly one of those ways)! It also appears that early-stage investing is the only way for lower-cap investors to get in on these deals since late-stage investors are blowing up valuations. The downside: very late-stage and roadshow investors are not going to get the pop they were hoping for. The secondary markets have eliminated much of the upside opportunity for them.

Let me know your thoughts in the comments as I’m curious to hear what you think about the state of the market!

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