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Everyone seems to have an opinion on the future prospects of Facebook and Twitter. Some of us even feel strongly enough to want to bet on it. Unfortunately, the companies are privately held, and unavailable to be bet on in the traditional way, via the stock market. It is not just household names like Facebook and Twitter that people might want to bet on, but also smaller companies like Weebly, or the Universal Record Database (URDB.)

Prediction markets occasionally exist concerning a single event of an individual company, but this represents only a fraction of the market opportunities that can be made available. I propose creating a large number of prediction markets, perhaps 500-1000, covering all types of companies: Those near liquidity like Facebook and Twitter, those that recently received Series A or B venture financing, and even those that are running on seed or angel funding, or with no outside investment at all. Each company could have a series of markets to assess its current value and prospects for success. While verifiable information concerning private companies is often hard to come by, there are a variety of metrics that could be used as the basis for markets:

- If and when a company goes public, as well as its closing IPO valuation

- If and when a company is sold, as well as its sale price (if disclosed.)

- Number of registered or active users.

- Website traffic (this is most applicable for certain types of companies, like Social networking)

I like to think there are many more applicable measures of success that can be used and would love to hear any suggestions from our readers. Most likely each sector has some specific metrics that are applicable to evaluating success or failure. With enough volume, a market for valuing private companies would emerge. This might not be as far off as you think.

The Commodity Futures Modernization Act allows for real money prediction markets that operate as an Exempt Board of Trade (EBOT.) The American Civics Exchange (ACE) is one of the first companies to take advantage of EBOT status. While today they have only a few markets, which concern tax changes and other political actions, they anticipate expanding to include contracts that allow individuals and business to hedge against a legitimate risk. Examples could include FDA drug approval, the outcome of major class action lawsuits, and even health care reform. Unfortunately, trading in these markets is restricted to high net worth individuals, and contracts relating to the success of private companies is likely prohibited. Still, this exchange represents a step in the right direction.

Recently, Google, Yahoo, and Microsoft co-wrote a letter to the Commodity Futures Trading Commision (CFTC) asking for “small stakes” real money prediction markets. They believe that real money prediction markets have the “potential to provide significant public benefit.” My guess is they believe there is significant money to be made as well, but that is ok with me. Momentum is building, and an actual real money stock market for private companies may not be far away.

While I would like to personally bet on the success and failure of many companies, I’m also curious how accurate the markets will be in predicting success. I think that the younger (not necessarily in absolute time) a company is, the less predictable its prospects become. Kevin Dick believes small groups like angel investors and venture capitalists can’t pick winners at the seed stage. But what about large groups and the “wisdom of crowds”? Perhaps aggregating information via prediction markets can yield better signals about a company’s prospects for success. Assuming it can, this data will be of interest to a number of parties including potential acquirers, partners, analysts, and even customers. You don’t really want to use a company’s products if you think they are going bust, do you? Today, if you have that opinion, there isn’t much for you to do other than decline to buy its products. But soon you might be able to bet on it and turn a profit.

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  • Prediction Markets for Valuing Private Companies | Midas Oracle .ORG

    [...] Cross-posted from emergentfool. [...]

  • rafefurst

    Not surprisingly, I would also love to see such markets too. One thing I suspect will be a hurdle is the perception of (and actual potential for) manipulation. If the market on a startup’s prospects is worth more than the startup itself, won’t corruption be inevitable?

  • danielhorowitz

    @Rafe - You bring up a good point. Gaming the system will certainly be an issue. To prevent it, we would likely have to limit the total potential value of outstanding contracts to some fraction of the value stipulated in the contract. e.g. If there is a market for a startup valued at one million then the total value of outstanding contracts can only be 100-200k. Also, all trading will have to be completely open and transparent, much like the standard stock market should be. Then, if a founder or insider starts dumping shares then people know something is up, and can react accordingly.

  • David Pennock

    I think this is a great idea. Steve Lawrence proposed this idea while we were at NEC and we pursued but not to completion creating a game called, or startup exchange. Along the way we met a Canadian entrepreneur named Leonard Brody who went much further but still not to completion under the better name (play on pre-ipo).

    There are legal pre-ipo markets in Germany.
    Apparently illegal (“gray market”) but popular versions of these operate in India as well. (One of the many things I learned during my recent trip to Bangalore.)

    It may be that both the regulatory environment and the public appetite is more ripe for this idea now. I say go for it!

  • intradaytips

    Hi, All,
    i am satisfied with all . so i want to share my ideas………..
    Prediction markets are speculative markets created for the purpose of making predictions. Assets are created whose final cash value is tied to a particular event (e.g., will the next US president be a Republican) or parameter (e.g., total sales next quarter). The current market prices can then be interpreted as predictions of the probability of the event or the expected value of the parameter. Prediction markets are thus structured as betting exchanges, without any risk for the bookmaker.
    People who buy low and sell high are rewarded for improving the market prediction, while those who buy high and sell low are punished for degrading the market prediction. Evidence[citation needed] so far suggests that prediction markets are at least as accurate as other institutions predicting the same events with a similar pool of participants.

    hi, i am new to this name is sanjeev. I am a technical analyst. i give stock tips for Indian stock market .

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