Nasdaq-SharesPost deal provides liquidity at the price of transparency

If you’re a founder or an investor, you’re going to love the new marketplace for trading shares in private companies that the Nasdaq is setting up with SharesPost.

That’s because this market, called the Nasdaq Private Market, will provide a lot of liquidity. Those pre-IPO shares in a once-promising company that hasn’t shown much growth in the past year? They used to be a drag on your portfolio — now you’ll be able to unload them and turn them into cash.

“From an entrepreneur and VC perspective, this is a good thing,” Ajay Chopra, general partner at Trinity Ventures, told me via email today. “One more avenue for capital formation and liquidity, particularly in turbulent times when the IPO window is closed, is hard to argue with.”

It’ll be good for founders who have spent years of toiling away on their startups while drawing minimal salaries and still have nothing to show for it because all their equity is locked up in private company shares. Instead of having to structure strange investment rounds where the majority of the cash goes right into the pockets of the founders as a way of giving them an early payday, those founders will be able to list some of their shares on this marketplace and sell them more efficiently.

It will also relieve some of the pressure for companies to go public before they’re ready. An IPO has a lot of downsides, not least of which is the enormous time and expense of setting up the IPO, going on a roadshow, defending your financials, and more.

“An increasing number of companies are choosing to remain private longer, which requires an efficient means to access liquidity for employees and investors,” Nasdaq said in its press release. “NPM will offer a complete, end- to-end solution that will enable a private company to control the marketplace for its shares. Transactions on NPM will meet NASDAQ OMX’s industry-leading standards for security, compliance and client support.”

But here’s the troubling thing — at least for me, as a journalist. There’s a disturbing trend toward secrecy and opacity in the tech markets, and I’m concerned that NPM will only contribute to that.

Private companies are not held to the same standards of disclosure as public companies are. Once a company has held its IPO, it has a responsibility to file quarterly earnings reports and to publicly disclose anything material to its business. (Sometimes those requirements become ridiculously bureaucratic, as when a company is required to file an SEC disclosure every time its chief executive tweets something about the business, which is one reason companies find them so annoying.) The Sarbanes-Oxley Act imposes additional restrictions, making executives personally liable for misstatements in a public company’s reporting. And then there’s no telling which direction the “wisdom” of the markets will push your share price, as Facebook discovered last year to its chagrin.

Or, as a spokesperson for SharesPost competitor SecondMarket told our reporter today, “Coupled with the recent reports that Nasdaq itself was considering going private, this announcement is a telling admission that companies increasingly wish to avoid the casino-like atmosphere of the U.S. public markets.”

Merely filing for an IPO carries with it certain disclosure requirements, which help would-be investors evaluate the company and decide whether it’s worth buying the stock. Or, it did — until the JOBS Act passed, and with it, provisions for companies to start the IPO process in secret.

What’s more, even an ordinary public offering has built-in ways to give certain investors more information than others, as we saw during the Facebook IPO. The biggest Wall Street investors were privy to details about Facebook’s revenues (specifically, its difficulty in making money from mobile traffic) that were withheld from the broader market. At the time, that seemed to me like it was in direct conflict with the purported mission of making information as widely available as possible in order for the stock market to function freely and fairly.

Now, in addition to preferential pre-IPO treatment for certain investors, companies also have the option of “testing the waters” by secretly filing pre-IPO paperwork. Or, through a private marketplace like the NPM, they can skip the IPO process entirely and create a private, less-regulated market for their shares.

I asked Chopra if he shared my concerns, and here’s what he said: “If a company really wants to place securities using a private exchange, they may have to be more forthcoming with disclosing their financial information.”

But then he acknowledged that high-profile companies have more latitude, because there’s a lot of demand for their shares, with or without transparency.

“In which case potential investors have to weigh the risk vs rewards of consummating such a transaction,” Chopra added.

As VentureBeat’s Jolie O’Dell reported earlier today in her analysis of the NPM, “companies will exercise vast amounts of control in Nasdaq’s version of the private, secondary market.”

Bottom line: This liquidity is a welcome change for investors, founders, and employees with stock in the startups they work for. I’m just not sure it’s the best thing for the public, or for anyone on the buying side of these increasingly private marketplaces.

Without full transparency about these companies and their financials, anyone purchasing shares on a private market will need to remember two important words:

Caveat emptor.

Photo credit: NASDAQ