Private markets — like those that trades share of Facebook — are elitist, discriminatory, and at the same time, entirely appropriate.
FORTUNE — I can’t buy Facebook stock, even though there are plenty of shares for sale. You probably can’t either, because such deals are transacted on exclusive, private markets that shun the vast majority of Americans. It’s elitist. It’s discriminatory. And at the same time, it’s entirely appropriate.
Private placements, in which companies raise capital from a select group of investors, have been around for decades. Typically they are institutional deals, like early investments in Facebook by hedge fund Clarium Capital and venture capital firm Accel Partners. What has happened recently is that a new group of intermediaries has emerged to help democratize the process, creating virtual auctions in which individuals can buy shares just like the institutions- not only in Facebook but in other hot private companies such as Groupon, Twitter, and Zynga.
What hasn’t changed is that the SEC still restricts participation to “accredited investors.” There are a variety of ways to qualify, but the most common is to have at least $1 million in net worth (excluding your home). Some lower earners can gain indirect access via workplace retirement plans- some of which invest in VC funds and hedge funds- but only if you happen to work for the state or for one of the very few companies left that still give guaranteed pensions. For a variety of legal and strategic reasons, most 401(k) participants need not apply.
All this sounds mighty inequitable. Economics blogger Felix Salmon sums up the distress: “What I’m worried about is that the masses will end up owning the dregs of the capital world- the overpriced stocks nobody else wants.”
But the solution is not to put a share of Twitter in every pot. In fact, it may even be counterproductive. For starters, there is no guarantee that these investments will be profitable. Even the best venture capitalists usually hit just one home run in every 10 at-bats, then mix in a few singles or doubles before whiffing on the rest. And that’s with the advantage of underlying financial information and access to company executives, which are absent from many of these private market sales (buyers usually get little more than third-party estimates).
More important, companies like Facebook believe that it is in their best interest to remain private as long as possible. If you trust their judgment- which you must if you’re among those clamoring for Facebook stock- then you also should trust that staying private is the surest way for them to continue adding new jobs and creating more wealth for their employees (most of whom are not yet plutocrats).
Historically, companies graduated from private placements to public offerings because the latter could produce larger investments and higher profiles. Plus, it was the only way to provide a continual liquidity option for employees.
In fact, that’s the very reason that public stock exchanges were created: to help companies grow. If private industry has found a new means for achieving the same end- or at least for getting a few stops farther down the freeway- then by what right do we compel them to offer us shares? We put all sorts of rules on private enterprise, but never have thrust unwelcome owners upon them. It’s the sort of tipping point that would make many prospective entrepreneurs run for the nearest consulting job.
Moreover, there are valid reasons for the accredited investor standards (which had been static since 1982, until Dodd-Frank opened the door for “price inflation” adjustments). Investments in private companies carry much more risk than do public stock purchases, because of the dearth of available information. That doubles for young companies, particularly tech ones, which often burn out after an initial flame of popularity.
Even if we assume equal investor IQ between the rich and the rest, the former still can better afford to take the loss that, more often than not, is coming. The SEC doesn’t require that I do proper due diligence before blowing my life savings on a lousy public stock, but it at least ensures that I have had the opportunity to do so.
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