Private investments in public equities that bypass Wall Street stock exchanges are one of the hottest methods for smaller companies to raise capital.

But there's a downside: The shares acquired under so-called PIPES can be restricted from trading for months or even years pending their registration with the SEC.

Now, a Los Angeles-based start up called Zealous Trading Group Inc. has launched a unique electronic marketplace. It is a space where the owners of restricted stock can buy and sell that stock among themselves. Normally, they must seek each other out independently, since such stock cannot be sold on an exchange.

The company's Web-based trading platform called Zats isn't for everyone. It's generally open only to big money players such as hedge and mutual funds, broker-dealers, registered investment advisors and venture capitalists. Individual investors can qualify but they must be deemed "accredited" under SEC rules and have to have high net worth. Still, about 100 entities are already using the trading platform, with 2,100 on a list waiting for a new version to launch.

"There's demand left and right for liquidity in this segment and no centralized place for people to trade what they owned," said founder and Chief Executive Todd Ault, a longtime investor in start up and small companies. "We're taking an asset class that was really archaic to trade, and we're making it easier and more efficient."

Zealous' trading platform isn't the first such electronic marketplace. Stock exchanges and major banking houses from Nasdaq to JP Morgan in the past year have launched or upgraded services such as Portal and Opus-5 to handle specific segments of the restricted market, such as securities that can only be bought and sold by large institutional buyers.

Zealous has a more direct competitor in New York-based Restricted Stock Partners, which launched in 2005 as a largely telephone-based service. RSP already has established relationships with traders and launched its own electronic platform late last year.

But Ault is counting on what he maintains is ZATS greater transparency, as well as its ability to handle a wider variety of restricted securities, to propel Zealous past its competitor. (Zealous went public itself last year in a reverse merger and trades over the counter for just 10 cents.) Illiquid assets that can be traded on Zats run from restricted stock to warrants and convertible notes for future stock.

Stephen Bruel, an analyst with TowerGroup's Securities and Capital Markets practice, who is familiar with both Zealous and Restricted Stock, declined to comment on which platform may be better. But he favors their establishment in general.

"Creation of markets for these kinds of securities is important for companies because investors are more likely to purchase a security if they know they can sell it more easily than they've traditionally been able to," said Bruel. "Also, the more restricted a security, the more of a liquidity discount you need to provide to the initial buyer. That's less money for the company."

Hot pipes

With IPOs and secondary offerings harder to mount in recent years, especially for small companies, doing a PIPE after going public via a relatively inexpensive reverse merger often can be the most efficient way to obtain growth capital.

For investors, it's often a chance to pick up shares at discount, or for secretive hedge funds making large purchases to protect their identities under the looser rules governing PIPES.

And while exotic mortgage-backed securities fell into disfavor after the subprime collapse last year, PIPES were one of the fastest growing asset classes in 2007, according to industry monitor PlacementTracker. It recorded a record 1,362 deals valued at $81.4 billion in the U.S. alone, nearly double the value of the prior year.

"We don't see the level of PIPE activity leveling off anytime soon," said Brian Overstreet, chief executive of San Diego-based Sagient Research, which operates PlacementTracker.

ZATS opened this fall to a select group of broker-dealers and hedge funds, some of which are investors in the venture itself. Investors included Los Angeles-based Bristol Capital Advisors LLC, which declined to comment.

In the next several weeks, Zealous plans to unveil a second-generation platform that will make the service available to a larger number of investors, including very wealthy accredited investors.

Zats membership is free, with Zealous making its money by receiving a share of the commissions from brokers who complete transactions transactions Ault figures they wouldn't complete in the first place without Zats.

While a member theoretically could complete an entire transaction paperlessly and without involving Zealous staff, the company expects that many traders initially will be more comfortable with some handholding to ensure the complicated settlement process is correctly handled. That's in part why Zealous last week expanded its New York branch office to nearly a dozen people. A small Boston office has opened and a San Francisco office is planned.

Ault is counting on viral marketing to rapidly increase membership and get more securities listed. Zats offers its own broker-dealers to complete settlement of a deal, but the preference is for members to use their own broker-dealers.

"We want to be the neutral third party, providing buyers and sellers the opportunity to link up," said Ault, noting that his company might only take 20 percent of a commission in a transaction. "We share the commission with the broker, because then they'll get more of their other clients involved."

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