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SAN FRANCISCO (Reuters) - Kevin Ryan, chief executive of online retailer Gilt Groupe, is keeping close tabs on congressional legislation that might enable him to have more shareholders in his young company.
Barry Silbert, chief executive of SecondMarket, an exchange for trading of private-company shares, is keeping close tabs on Ryan.
Gilt Groupe is one of the most-followed companies on Silbert's nascent stock market. Winning over executives like Ryan, who in many cases can decide if and how their company's shares are traded, is key to SecondMarket's future.
"We meet with them all the time," Ryan said of SecondMarket. But he's reluctant to endorse wide trading of private Gilt Group shares for fear of breaching the 500-shareholder threshold that, under current Securities & Exchange Commission regulations, would require public disclosure of financial information.
Relaxing that rule is among the proposals currently before Congress, and Ryan is eager to see such a change. "If Congress did pass the law, we would look at changing our policies," he said.
Ryan, along with other executives of start-ups including Twitter CEO Dick Costolo, wrote to Congress last week urging quick passage of a new rule. The change would make it easier for companies to stay private longer, and that in turn would likely expand the universe of private-share trading.
For Silbert, the time to court Ryan and dozens of other start-up executives is now, so they are ready to do business with him if the rules change. If more shareholders were allowed, companies might loosen internal policies over who can sell equity. At Gilt, for example, current employees cannot sell shares on SecondMarket, Ryan said.
The proposed rule change comes at an especially crucial time for SecondMarket, which stands to lose one of its largest generator of share transactions, Facebook, if the social networking company goes public next year as expected. Before they went public, shares of Groupon and LinkedIn traded on SecondMarket.
Committees in both houses of Congress have held hearings on relaxing the 500-shareholder rule, and people familiar with the matter say legislation is likely to come up for a vote by the full House of Representatives and Senate early in 2012.
Lawmakers from both parties view the change as supporting young companies and job creation, important for establishing voter credibility during an election year.
Even without the rule change, trading of secondary-market shares is expanding fast. SecondMarket facilitated $450 million of private-market transactions this year, up from $400 million last year. Transactions at SharesPost, a rival to SecondMarket, went from a few dozen last year to more than 1,000 this year, CEO David Weir told the audience at the AlwaysOn Venture Summit on December 14.
"It's certainly my goal to create that new growth market," Silbert told Reuters about his business, which he founded in 2004. SecondMarket offers trading of fixed-income products and restricted securities of public companies in addition to private-company shares.
In November, SecondMarket closed a $15 million funding round from former Facebook executive Chamath Palihapitiya's Social + Capital Partnership that valued the company at $200 million. Many employees have shares, and some have sold them on SecondMarket.
But trading on private-share exchanges won't become mainstream. For one thing, only investors who certify that they have a net worth of more than $1 million and meet other requirements are allowed to trade.
And trading on the emerging private-share exchanges remains limited on the company side too, with Facebook accounting for a large chunk of transactions. Numbers for specific companies aren't broken out, but SecondMarket said that 62 percent of completed private-company transactions last quarter came from the consumer Web and social-media sectors.
Silbert is working hard to court start-ups of all stripes, ranging from Gilt to cloud data-company Box.net, but expanding beyond a few well-known names will not be easy.
"Liquidity begets liquidity," says Jay Ritter, a finance professor at the University of Florida, referring to how easy it is to sell an asset. "If a buyer is concerned about a potential lack of buyers in the future, that buyer may not want to make a purchase in the first place."
There is also the question of fraud by private companies, which aren't required to meet SEC disclosure requirements. Existing investors in private companies could try to game the markets by bidding up share prices before cashing out.
To combat that, SecondMarket typically requires companies whose shares are traded on its exchange to provide audited financial statements. It also gives companies the ability to accept or reject any trade.
There is an exception to that disclosure requirement: Facebook. Silbert argues that the existence of so much data about that company, such as leaked revenue and profit figures, makes up for the lack of audited financial statements.
While many shareholders have the right to trade their shares without a company's permission, Silbert works hard at enlisting the company's cooperation, figuring that will mean bigger business down the line. That might mean agreeing to let the company's stock trade only in limited investment windows to buyers pre-approved by the company, for example.
Creating a mechanism for employees to sell shares relieves some of the pressure on successful start-ups to go public quickly, Silbert says. Still, many companies seem lukewarm to the idea. Twitter's Costolo, though in favor of lifting the shareholder limit, has called trading on secondary markets a distraction.
Meanwhile, some investors tout the benefits of the private-share exchanges, saying they provide companies with more options and ease the transition from tightly held to publicly traded.
At the Venture Summit, Michael Moe, CEO of GSV Asset Management, said that in an environment where companies are generally staying private years longer than they had before, allowing employees to cash out pre-IPO helps create a more motivated workforce. He speaks from experience: earlier this year, GSV bought 225,000 Facebook shares through SecondMarket.
Reporting by Sarah McBride in San Francisco; Editing by Jonathan Weber