PEHub: McCusker Comments on More Startups Looking At Secondary Market Trading Restrictions

More Startups Look At Secondary Market Trading Restrictions

Secondary markets, what's not to love? Liquidity for private company founders, opportunities for venture investors to unload portfolios, LPs taking positions in hot private companies.

With all the excitement, activity is on the rise. During the first half of the year, transaction volume at the SecondMarket exchange for private company shares rose 75% to $268 million. (I won't supply the corresponding Dow statistic.) SecondMarket has even begun listing its own shares on its exchange.

So it is probably no surprise that an increasing number of startups have begun to impose restrictions on secondary market trading. If key engineers and employees shed their shares in a young company, what incentive do they have to work hard for its future?

Experts say the activity has jumped in the past six to 12 months, with a few of the most determined companies writing trading prohibitions into their incorporation papers from day one.

As many as 10% to 20% of B and later stage companies now are taking steps, says Anthony McCusker, an attorney at Goodwin Procter (pictured). “I think it will increase over time.”

The efforts include changing company bylaws and convincing current and former employees to retroactively live under the new trading restrictions. Companies have had surprising success getting employee permission, says McCusker.

Other measures involve venture investors and include attempts to impose trading windows and limits on which employees can sell, say people following the changes. Already, term sheets give companies the right of refusal on stock deals.

The activity has indeed increased in the past six months, says Mark Heesen, president of the National Venture Capital Association.

The challenge is that secondary trading has become so accepted that as many as 50% of expansion and later stage deals now come with some liquidity for founders. The question is how to keep the next 200 employees from demanding the same treatment.

This post was authored by Founders Workbench.


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