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Emerging Secondary Market for Crowdfunded Securities

Crowdfunded equity investments are generally illiquid because there is no organized secondary market for crowdfunded shares. Secondary markets will emerge, however, not only for private securities in general, but some for crowdfunded shares specifically, as securities crowdfunding grows and evolves. In fact, the first secondary market for CF shares is scheduled to launch in September: I’m talking about CFX Markets, about which we’ll learn more below.

Proposed Venture Exchange Law

Congress and the SEC are exploring the idea of allowing “venture exchanges” to facilitate trading of securities issued by small companies. The proposed Main Street Growth Act, for example, would permit venture exchanges to connect buyers and sellers of small-company securities, but not to process transactions between those parties. The act defines small companies as those—both public and private—with assets under $2 billion. Here is a link [PDF] to the Main Street Growth Act, sponsored by Rep. Scott Garret of New Jersey.

Why not Redemption?

Some CF deals provide for redemption of preferred shares, where investors may have a right or obligation to sell shares back to the issuer. Redemption is not always a good avenue to liquidity for angel investors, however.

“As the sole entity in charge of buying back shares, the company potentially could keep the valuation lower than what others might pay in the open market,” explains Muhammed Saeed, a serial entrepreneur and developer of electronic trading systems for the securities industry. “There is little or no incentive at that time for the company to offer a higher price unless they are working with professional investors to ‘take out’ crowdfunding investors to clean up the cap table for an upcoming VC or institutional round.”

Some investors will not look at private securities offerings, even if redemption is an option, until a secondary market is established that provides some prospect of liquidity.

Secondary Markets Emerge

CFX Markets will be the first, and more (I predict) will follow. CFX “provides an open and secure network to facilitate secondary market transfers of private securities in alternative asset classes,” strictly for accredited investors. It is owned by PeerRealty, a real estate securities CF platform based in Chicago, but it will list crowdfunded shares originating on other platforms as well, including PropertyStake (real estate), CrowdFranchise (franchises), and more in the future.

Significantly, the issuer of securities will not have control over the terms of any transaction (such as minimum share price, maximum number of shares, or restrictions on who may buy, aside from basic SEC rules) on the CFX Markets platform, as issuers do on existing secondary markets like SecondMarket and Nasdaq Private Market (a joint venture of SharesPost and Nasdaq OMX).

Bloomberg reported that transactions involving sales of private securities by employees and angel investors reached a record $12 billion in 2013 and are expected to rise to $19 billion in 2014.

Liquidity Boost for Equity Crowdfunding

Not that securities crowdfunding isn’t growing like a patch of weeds already, but it should get an even bigger boost from the emergence of venture exchanges and secondary markets for crowdfunded shares. Many investors who might be reluctant to plunge into CF securities today, because of illiquidity, will feel a bit more enthusiastic about it as secondary markets emerge.

Continue with the next article in this series, “Watch Out for Sub-Prime Peer-to-Peer Borrowers,”

or read the previous article in this series, “Everything You Need to Know About Securities Crowdfunding,”

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About David M. Freedman

David M. Freedman has worked as a financial and legal journalist since 1978. He has served on the editorial staffs of business, trade and professional journals, most recently as senior editor of The Value Examiner (National Association of Certified Valuators and Analysts). He is coauthor of Equity Crowdfunding for Investors, published in June 2015 by…

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