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Who Wins if New Legislation Kills the 500 Shareholder Rule

Wednesday, 9 Nov 2011 | 2:31 PM ET
Lester Lefkowitz | Stone | Getty Images

You can bet a slew of Facebook employees are spending a lot of time pouring over a new bill in the Senate. The big question: will proposed legislation to amend a rule forcing companies to disclose financial data once they top 500 shareholders allow Facebook to delay its IPO? Will this remove the pressure for an IPO we've seen on startups like Zynga and Groupon? Meanwhile platforms for trading private company shares are celebrating.

The bill: Republican Pat Toomey from Pennsylvania and Democrat Tom Carper from Delaware are proposing the "Private Company Flexibility and Growth Act." They say the bill intends to "enhance small businesses and community banks... ability to create jobs and lend in their local communities." What it does is raise the shareholder limit for reporting requirements from 500 to 2,000, and it would exempt employees, so the number of actual investors a company could have before opening its books could actually be much higher. This follows a similar House proposal that passed committee last week and is expected to be voted on in the next month or so.

The Upside: Successful startups will no longer be forced to go public because they're growing and giving employees shares of stock. The 500-shareholder rule is a main reason behind Google's IPO in 2004 , and it's widely considered a factor in Zynga's IPO filing. It's also the reason Facebook is expected to go public next year. The question is whether the bill passes quickly enough to exempt Facebook. If it looks like it's going to happen Facebook could ask for a waiver. Zuckerberg said publicly in September that he wants employees to stay "focused on product developments rather than a pay-out." Perhaps it's no coincidence that this year Facebook dramatically expanded its lobbying team, growing its DC offices by more than a dozen people this year.

This would mean that companies like Groupon's rival LivingSocial (backed by Amazon ), Square, and Twitter, can take their sweet time growing before they have to open the kimono and deal with the hassle and expense of going public.

The downside: The concern is that if companies aren't forced to open their books, investors could get duped. The 500-shareholder rule was designed so only "accredited investors" or professionals, like Venture Capitalists, could access shares of companies that don't disclose financial information. One version of the House bill took the proposal one step further, and removed the requirement that investors be 'accredited,' though that was removed from the current version. Now, where both of the bills stand, everyday Joe investors still won't be able to get a piece of private companies, but these startups could open their doors to a much wider range of investors.

Who REALLY Wins (other than Facebook): The platforms that trade private shares are in for a major spike in business should this legislation be passed. There's no question that platforms like SecondMarket are celebrating what could be a real boon to their business. Barry Silbert, the CEO of SecondMarket kept his reaction very focused on the *other* companies that will benefit from the new law: "Job creation is the number one issue in our country right now, and this bipartisan legislation is all about jobs, as it empowers private companies with the flexibility to continue to grow, hire and prosper – and ultimately go public when it makes strategic sense."

A number of companies are getting into the space -- like Liquidnet, which last month started a Private Shares group. And SecondMarket has made major inroads: trading surged 122% to $170 million in the third quarter. But if there's nothing forcing the biggest private companies to go public, they'd stay private longer, and more of their employees would cash out, and more investors would want a piece.

What does this mean for VCs? Venture Capitalists traditionally rely on IPOs to cash out their investments, so now they may be changing the time frame in their models. We'd surely see more VCs look to exit at least part of their stakes, by selling on the secondary market. And the option of selling to another company may become more appealing.

Questions? Comments? MediaMoney@cnbc.com

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  • Working from Los Angeles, Boorstin is CNBC's media and entertainment reporter and editor of CNBC.com's Media Money section.