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Tech Bubble 2.0: It's a Private Thing


It takes companies an average of nine years to go public. No wonder investors stand to make the big bucks on private exchanges.

Driven by social media, cloud computing, and mobile startups, Tech Bubble 2.0 has investors ready for a feeding frenzy. LinkedIn (LNKD) rose 55% on its first day of trading last May. Groupon's (GRPN) $700 million IPO was the biggest since Google (GOOG). Social-business company Jive Software (JIVE) catapulted up 44% this month alone. Tech companies are hiring like mad, with newly-minted MBAs choosing Silicon Valley over Wall Street.

Unlike the first dot-com bubble, however, many of today's tech companies are making money before going public. Zynga (ZNGA) reported earnings of $30.7 million pre-IPO; Groupon arguably raked in $688 million in revenues. Compare that to Amazon (AMZN), which went public in 1997 at $18 per share, and only reported its first net profit of $5 million in Q4 2001.

Then there's Facebook. On February 1, Facebook filed for a $5 billion IPO, the biggest Internet public offering in US history. Profits topped the $1 billion mark last year, thanks to advertising and Zynga revenue. Facebook's market cap, as determined by secondary markets, is hovering around $98 billion, more than twice that of Ford Motor Company (F).

"I don't ever recall a pre-public company getting this much attention before going to market, including a Hollywood movie," said Lloyd Khaner, general partner of the hedge fund Khaner Capital and contributor to Minyanville. "All that attention may give Facebook a bigger multiple than it might have had. I've never been more interested in what's going to happen to a company than I am now."

All that, and Facebook hasn't even gone public. Or has it?

Facebook: The Ultimate Public-Private Entity
Like Zynga, Groupon, and LinkedIn before it, Facebook already has a multi-year tenure on a private online exchange. These secondary markets allow employees, founders, and early investors to sell their shares to institutional and accredited investors, including venture capitalists. Facebook, the flagship investment of SecondMarket, one of the biggest online exchanges, may even have caused private exchanges to go viral.

Private-exchange transactions exceeded the $1 billion mark in 2011. SecondMarket reported a transaction volume of $558 million during 2011, a 55% increase from 2010, according to PEHub. One-third of SecondMarket's 2011 revenues came solely from Facebook, where employees are allowed to cash out on 30% of their holdings pre-IPO. Twitter, Yelp, Dropbox, Foursquare, and other familiar names are actively trading on secondary exchanges, quietly establishing foundations for their own IPOs.

The Market Made Them Do It
The proliferation of secondary exchanges represents a fundamental shift in the way companies go public. Back in the halcyon days of the first dot-com bubble, words like '9/11' and 'financial crisis' had yet to enter the collective vocabulary. A grand total of 675 companies went public in 1996, at the height of the bubble, according to the San Francisco Daily Journal. Compare that to a high of 255 IPOs in 2010, including TARP-induced offerings like that of General Motors (GM).

Today's IPOs aren't, on average, offering the kinds of returns investors can sail into the sunset with. In August 2011, average IPO returns were down nearly 6.7%, according to the LA Times, compared with a 25% gain in 2010 and 16% in 2009. The range-bound stock market, increased regulation, recessionary investors' risk-aversion, and a still-sluggish credit market mean companies take an average of nine years to go public. Private exchanges are a convenient and increasingly necessary way for private companies to solidify their positions in a challenging economic climate.

Private Exchanges Filter Out Financial Nutrients
While private companies use the exchanges to establish their pre-IPO financial foundations, elite investors, having a centralized way to get in early, stand to maximize their potential returns. Everyday investors can also grab a sliver of the pie through publicly listed funds such as the Keating Pre-IPO Fund (KIPO), a dedicated pre-IPO fund with investments in several industries, or GSV Capital Corporation (GSVC), which has holdings in well-known tech companies listed on private exchanges, including Twitter and Facebook.

The future is up for grabs, both for companies like Facebook-remember what happened to MySpace?-and the private exchanges themselves. And the IPO landscape has, perhaps irrevocably, been altered.
No positions in stocks mentioned.

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