Facebook may be private, but that doesn't mean it's out of reach — accredited investors can actually buy shares of companies years before an IPO.
How is that possible?
A new exchange called Second Market, just down the street from the big board, specializes in trading illiquid assets, and shares of private companies in particular. While companies wait longer to go public, this creates a new kind of liquidity for employees and a new opportunity for investors. And it seems to be a great business for Second Market, which charges 3 percent to 5 percent of each transaction—it's traded $250 million so far this year.
Here's how it works: to buy shares on Second Market you must be a certified accredited investor, which means you must have net worth of more than $1 million or annual income over $200,000.
And you can't just buy shares of any company—the company approves who buys and sells. Companies agree to let shareholders sell, so they can get some liquidity if there's no IPO on the horizon. But companies often limit sellers to former employees, in order to keep their workforce feeling invested, so to speak.
How do companies decide who can buy? Many companies want to keep their number of investors under 500, which triggers certain financial disclosures. So often companies restrict their buyers to employees or funds that already own shares in their company.
The private companies can weigh in on the price of their shares, and they can charge fees. Facebook and Twitter each charge sellers $2,500 per transaction; Zynga charges $6,000. SecondMarket explains that these are simply an administrative cost for the company to handle the paperwork. The company is acting as a transfer agent, which comes with costs. But SecondMarket covers these fees — their average transaction is $2 million, so it's worth it for the trading platform to cover the cost.
The list of companies available on Second Marketall comes down to supply and demand. The longer companies stay private the more we'll see of both — employees eager to get some liquidity and investors eager to get a piece of growing companies. We'll have details on Second Market's Q3 trades on Tuesday - tune in to Squawk on the Streetfor my first segment!
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