In 2008, Gideon Yu, then the chief financial officer of Facebook Inc., began steering some former employees who wanted to sell shares in the social network toward a specific buyer.
The firm, Millennium Technology Value Partners, paid about $10 million to acquire stock from about a dozen former employees of Facebook, according to people familiar with the matter.
Sam Schwerin, managing partner of Millennium Technology Value Partners, in his New York office.
Run by two alumni of private-equity firm Blackstone Group LP, Millennium won Mr. Yu's backing in part by vowing not to make purchases without Facebook's approval, the people said.
Millennium is one of a handful of managers that specialize in what has become known as secondary-market investing in shares of young companies that aren't yet traded on major exchanges.
The median age of companies backed by venture capital at their IPO has risen to nine years in 2010 from four years in 1999, according to the National Venture Capital Association. That is in part because of investors' sour memories of the "tech wreck" of 2000-02 when valuations cratered after the late-1990s bubble.
As the time between companies' creation and their listing has lengthened, secondary shares have become a new asset class between venture-capital investing in startups and public markets, says Jason Jones, chief executive of HighStep Capital, which also invests in pre-IPO stocks.
While high-profile exchanges like Second Market Inc. and SharesPost Inc. have become the face of secondary-market trading, dozens of investment funds and vehicles have quietly emerged to buy such stock.
"Private company secondary funds are the new small cap funds," Mr. Jones says. Others whose funds are open to wealthy and institutional investors include Saints Capital, Industry Ventures, and W Capital Partners.
The payoffs can be eye-catching. The 2006 Millenium fund that bought the Facebook shares had annual net returns of 30% on average, according to one investor.
But as Facebook, the eight-year-old darling of pre-IPO investors, prepares for a high-profile listing in May, the market is at a crossroads. Once Facebook joins other big-name social-media companies like Groupon Inc. and Zynga Inc. on the public markets, it isn't clear the secondary market can retain enough depth and breadth to deliver large returns to a growing number of investors.
"This has become a very popular way to invest and there may be too much capital chasing these types of investments," said Marc Paley, managing partner at Scura Paley & Co., an investment banking boutique serving middle-market companies.
To be sure, there remain several heavily traded companies on pre-IPO markets, including social-media messaging service Twitter Inc., discount-deals service Living Social Inc. and flash-sale website Gilt Groupe Inc. But global volumes of private-company trading are expected to decline by 24% to $7.1 billion this year due to Facebook and other market exits, according to Nyppex LLC, which tracks and also trades in the market.
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Daniel Burstein, a former Blackstone Group banker, is now a managing partner at Millenium Technology Value Partners.
The market also has been dogged by questions about lack of disclosure and transparency. Last month, the Securities and Exchange Commission charged two managers of investment vehicles formed to hold Facebook shares with "pocketing undisclosed fees and commissions." One of the managers is fighting the charges; the other settled the case by paying a penalty without admitting or denying wrongdoing.
At the same time, recent regulatory changes could make pre-IPO funds less appealing for companies. One reason funds such as Millennium have been able to get stock is that companies have been required by securities rules to disclose financial information when their shareholder base exceeds 500. That rule has motivated companies like Facebook to channel pre-IPO stock sales to single, large investors, to keep the shareholder base down. Last week, however, the shareholder threshold was increased to 2,000 under a new law aimed at relaxing some securities rules for smaller companies.
Millennium executives say the future remains bright. "We see many reasons why secondary will continue to grow even further in the coming years," says Sam Schwerin, the former Blackstone banker who owns and runs Millennium.
Millennium, which raised a $284 million fund in 2010, eventually made investments in more than 50 private companies before an IPO or sale, including Twitter, online textbook rental service Chegg Inc., and apparel vendor Zappos.com Inc., all with management sponsorship similar to Facebook's.
"Clearly Facebook drove the acceptance of the market," accounting for a majority of recent trading in pre-IPO stocks on exchanges, says Christopher Yang, who specializes in technology at Grove Street Advisors LLC, a Millennium investor that advises pension funds on venture investing. Still, he adds, "the market potential continues to be quite large and is only growing."
Mr. Schwerinthe architect of the strategy of seeking companies' approval before buying shares, says companies still want to stay private longer, thus forcing employees and other investors who want to cash out to use the secondary market. The asset class "has gone from obscure, unloved and sometimes unwelcomed a decade ago, to widely accepted and a fundamental part of the venture capital ecosystem today," he says.
Millennium's own evolution underlines how secondary markets have changed. The current firm is the successor to three traditional venture funds formed during the tech bubble of the late 1990s by former Blackstone banker Daniel Burstein. with money from the firm's then-chairman Pete Peterson.
The first two funds of $4 million and $10 million scored stratospheric returns of 29 and nine times their investments, respectively, investors say. But when Mr. Burstein raised $160 million from outside investors under the Millennium name in 2000, the next fund fell flat as the bubble collapsed, barely eking out a profit. Two years later, Mr Schwerin joined and hatched the idea of buying from companies' employees and other investors with management's blessing.
Write to Randall Smith at randall.smith@wsj.com
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