The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.

It was 11:00 AM on Thursday May 18th, 2012. Traders huddled around their screens, eager to participate in the world’s largest internet IPO in history. It was intended to begin a new era of market confidence, but instead was plagued by technical glitches, confusing investors about the status of their trades. When the dust settled at 4:00 PM, Facebook’s stock had cost the NASDAQ $40 million. But a few blocks away, there was even greater cause for concern. SecondMarket, a firm that supports private company stock trading, had lost the crown jewel that accounted for a third of the company’s 2011 revenues. This should have been SecondMarket’s opportunity to come out of Facebook’s shadow and rest all doubts about its business model. Instead, SecondMarket turned its back on the offering that brought it fame, and has since made misguided efforts to fill the hole that Facebook left behind.

A New Place to Trade

Founded in 2004 by CEO Barry Silbert, SecondMarket acts as an online exchange for illiquid assets. Originally established to address the need for liquidity of restricted stock units, SecondMarket soared to new heights in 2009 when its platform began supporting trades in private company stock. This new offering made SecondMarket akin to a New York Stock Exchange (NYSE) for private companies, allowing current and former employees of private corporations to sell their stock ownership to accredited investors. When high-profile internet companies such as LinkedIn, Dropbox, and Facebook entered the platform, SecondMarket gained the attention of investors around the world. These corporations had a huge impact on SecondMarket’s top-line growth: Facebook accounted for a third of the $558 million total trade revenues in 2011.

Similar to trading platforms such as the NYSE, SecondMarket earns a fee when servicing a trade. SecondMarket’s specialization in illiquid assets commands between 3% and 5% per share traded, substantially higher than traditional trading platforms. Despite premium prices, accredited investors continue to exhibit eagerness for these unique opportunities. SecondMarket accounted for 75% of the $9.3 billion 2011 worldwide trading volume of private company stock.

But Now That Facebook is Public…

Before Facebook’s official IPO in early 2012, SecondMarket cut its workforce by 10% in anticipation of a decrease in demand for private stock trading on its platform. With substantial investor hype and a large number of equity–holding employees contributing significant trading volume, Facebook had an unparalleled impact on SecondMarket relative to other private companies traded on its platform. Given this impact, investors have questioned the sustainability of SecondMarket’s platform. In spite of the criticism, Silbert has continued to expand SecondMarket’s reach by offering a Bitcoin Investment Trust (BIT) as well as tools for convenient fund management and student loan issuing. As exciting as digital currencies or back office administration work may be, these new offerings represent fateful missteps that have distanced SecondMarket from what it does best: trading private stock.

BIT by the Bitcoin Bug

In 2013, SecondMarket introduced BIT, an open-ended investment that allows investors to gain access to the underlying value of Bitcoin without owning or storing the virtual currency, much like the relationship between the SPDR Gold Trust and gold. SecondMarket is primarily a trading institution and as such has no applicable expertise to act as a money manager that offers trusts in extremely volatile currencies. SecondMarket must also contend with a recently registered competing fund offered by the Winklevoss twins, infamously known for their battle with Mark Zuckerberg over the origins of Facebook. This fund plans to charge an expense ratio of around 0.5%, undercutting the 1.5% entry and exit fee and 2% holding fee system imposed by SecondMarket’s offering. SecondMarket’s BIT offers the same exposure to the digital currency, but lacks the cost efficiency that passive investors desire.

This focus on different product lines also distracts SecondMarket from servicing the current demands of its investor list. The company has been unable to satisfy investor demand since Facebook’s IPO. From Q2 of 2012 onwards, the amount of transactions demanded was five times greater than those that were processed. SecondMarket needs to reduce its product mix and focus more on its primary competency as a trading platform. By narrowing its scope, SecondMarket can keep doing what it does best and avoid confusing its valuable investors.

Being Second to None in the Secondary Market

Before considering new opportunities SecondMarket should first address the present issues in its private company stock trading platform. As SecondMarket’s investor base and demand for its trading services continues to grow, the company will need to increase the number of companies listed in order to generate more transactions.

To accomplish this, SecondMarket should seek to merge with the crowdfunding site AngelList to solidify a pipeline of private companies that are traded on its platform. A core function of AngelList is to set up aspiring entrepreneurs with accredited investors to raise money for their ventures. As different components of the US JOBS Act are ratified, an increasing amount of small businesses and start-ups will solicit funds from investors. Since this act promotes and allows for companies to stay private longer, the demand for private company transactions will only increase as employees of private companies seek avenues to liquidate their stock.

AngelList’s premium positioning in the crowdfunding market aligns with SecondMarket’s strategy of providing its investors with reputable and growing businesses and ideas. After start-ups receive funding on AngelList, they could then gain direct access and exposure to an even broader investor base for additional funding through SecondMarket. AngelList primarily consists of technology companies that use stock options and cash to attract top talent to work for them. If these employees then require liquidity for their vested stock options, SecondMarket can act as the medium to liquidate their options through its trading platform. AngelList’s involvement from the time of a start-up’s inception allows SecondMarket to discover the next Facebook or Twitter earlier in the growth stage.

Initially, the overall transaction frequency will increase only minimally due to the start-up nature of AngelList companies. In the long-term, this will be offset by the maturation of AngelList businesses as their shareholders develop a need for liquidity.

More Attractive Options

SecondMarket can also improve its company pipeline by targeting larger firms that can benefit from liquidity for their subsidiaries. Large technology firms such as Microsoft have had trouble attracting top talent due to the limited compensation that they can offer. Microsoft can offer a competitive base salary, but the potential upside on its stock options do not compare to that of growing technology firms like Dropbox.

SecondMarket could let companies like Microsoft use its platform to support stock and option trading in Microsoft’s subsidiaries. For example, Microsoft wholly owns Yammer, a social networking site for business. When attracting talent for Yammer, Microsoft offers its own stock options, which have limited upside compared to a potential stock option in its growing subsidiary. SecondMarket will provide a trading platform for a portion of Yammer’s shares and allow Microsoft to offer stock options in Yammer to attract the most sought after talent. Yammer’s employees can then use SecondMarket’s platform to reach accredited investors and achieve liquidity. This would be attractive to prospective employees as they will be provided with the substantial upside of a start-up firm and the liquidity and credibility of a blue chip firm.

Researching New Opportunities

Another possible avenue to increase SecondMarket’s company pipeline is to provide private companies with new value add services. Currently, SecondMarket provides its clients with capital raising and sales and trading services, yet does not offer research support. By partnering with a research team, SecondMarket could help investors cut through the clutter of the many offerings on its site. Research also helps listed companies: if a research team backed the prices of the attractive private startups, the valuations of these companies may be more accurately reflected in the market. This will promote confidence and facilitate equity analysis, allowing investors the chance to look at more investment opportunities thus promoting an increase in trading volume.

To provide its investors with research backing, SecondMarket should seek to partner with a research firm such as NYPPEX, a leader in private stock research. Over 625 leading worldwide institutions rely on NYPPEX for secondary private market insights and pricing. They could also partner with Preqin, a comprehensive private research firm that focuses on alternative investments. Although SecondMarket could develop its own in-house research team, the cost of developing a comparable calibre research team over a few years would greatly exceed the benefit of focusing on the demand of its current investors. Adding a pre-established world-class research arm to its portfolio will make SecondMarket an even more appealing trade platform, more effectively meeting the growing investor appetite for unique investment opportunities.

From Second to First

Instead of using the Facebook IPO as an opportunity to emerge from Facebook’s shadow, SecondMarket second guessed itself and strayed from its core competencies, but there is still time to get back on track. Re-emphasizing its private market platform can lead to more transaction opportunities for its investors, and potentially improve cross-selling with other product offerings. By focusing on its core product offering, SecondMarket can become the one-stop shop for illiquid assets and can solidify private company trading as a mainstream activity on Wall Street.

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