Pre-IPO Valuations: Creating a New Bubble?

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Do online marketplaces for shares in private companies, such as SecondMarket or SharePosts, lead to higher valuations once those companies go public? A recent study by the accounting firm BDO suggests this could be the case.

SecondMarket bills itself as an online marketplace in which buyers and sellers of alternative investments, including private company shares, can access market data, build an investor network and conduct transactions. SharesPost says it focuses on connecting private companies with current and future investors.

Although more than three-quarters – 79 percent – of the investment bankers who participated in the BDO IPO Halftime Report said that such marketplaces have a positive impact on the IPO market, nearly as many – 75 percent – said the current valuations of many companies are not justified. “Facebook raised bar on this,” says Lee Graul, capital markets partner with BDO. Although not yet public, Facebook's implied value on SharesPost tops $80 billion. Given its outsize valuation, Facebook may not have to go the IPO route, Graul notes. “Facebook is a game-changer.”

While not in Facebook's league, a number of other companies on Sharespost still boast impressive implied valuations. Groupon.com, the online coupon site is at $10 billion, while Twitter is at $8.2 billion.

Of course, billion-dollar valuations for companies that have yet to reach their teen years leads many to wonder if we're headed for another Internet bubble. And, 62 percent of the BDO survey participants said another dot-com bubble is at least somewhat likely.

Several forces appear to be boosting valuations. One is the small volume of trades in the pre-IPO market. “If you're only offering 10 percent of your shares and demand is high, the pricing will go through the roof,” Graul says. In addition, other Internet companies that recently have gone public came out of the gates blazing. Share prices for LinkedIn, for instance, doubled on the first day of trading, nearly hitting $123 per share, according to CNN. The company currently is valued at $10 billion-plus. Traders of pre-IPO companies may expect the same, once their shares hit the public markets.

At the same time, the businesses involved are actual businesses, Graul notes. Unlike those that made up the 1990s bubble, they are in operation and are bringing in revenue – although not all are turning a huge profit.

Still, the huge valuations appear to have caught the eye of regulators. In February, the Wall Street Journal reported that the SEC was investigating the online markets for shares in companies that still are private. They're concerned that the companies don't face the same disclosure requirements that public companies do. “This could be the beginning of a trend to get them more regulated in long run,” Graul says.

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Karen Kroll supplies the Business Finance community with reporting and commentary examining cash management and treasury-related topics.

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