In a closed-off part of Wall Street (where buyers are institutional investors, private equity firms, hedge funds and people who consistently earn more than $200,000 a year) Twitter shares have already been trading. Yes, already trading on what’s called the secondary market. Industry professionals have a nickname for these deals: “secondaries.”
These pre-IPO deals are driven by employees and other insiders who don't want to wait for an IPO to cash out.
"These kinds of people -- meaning early investors, current employees, and ex-employees -- sell up to X percent of their vested holdings. Buyers are also pre-determined," explained Sudhir Kandula. His company, SecondMarket, creates customized online exchanges for each deal it handles. It’s essentially a website through which employees can log on and decide how much they want to sell. SecondMarket also ensures everyone gets paid after shares are sold. Twitter is not trading on SecondMarket.
"So if you want to look at a profile of a typical company that does this: 100 employees or more, $50 million to $60 million in revenue," said Kandula.
For investors able to get in on pre-IPO deals, the gains can be tremendous when a company's shares finally begin trading on established stock markets, yet there are also big risks.
Take Facebook for example: Before the company announced it was going public, shares on the secondary market traded between $38 to $45. Twitter has recently traded between $27 to $32 a share. The microblogging company announced on Wednesday that it would set a price of $26 per share for its public offering on Thursday, making many of its employees and early investors instant millionaires. However, unless the stock rises above $32 a share the last people to buy Twitter on the secondary market could lose more than 20 percent on their investment if they sell.
Once a company goes public, all investors -- even those who bought in on the secondary market -- become stockholders and the value of their stake is determined by the daily movements of financial markets.
Secondaries are still a risky and loosely regulated part of the financial world. The Securities & Exchange Commission started taking a hard look at secondary markets as activity picked up in the years before Facebook went public. The Commission has filed civil charges against some firms dealing in this space for allegedly misleading investors and pocketing undisclosed fees and commissions. Part of what makes secondaries risky is the lack of financial data private companies disclose.
"This is an incredible illiquid market, where you have very little publicly available information” said Regulatory and Compliance attorney Martin Rosenburgh. “Quite often you have no history of reported earnings."
For its part, SecondMarket says it requires firms to make audited financial statements available to buyers and does not create securities or look for investors. It simply connects per-determined buyers and sellers. The company has seen incredible growth. Its deals are up 67 percent over last year.