The evolution of Private Markets: Dawn of a New Horizon

Introduction

I thought for this week’s piece I would focus on private markets, and particularly on the changing nature of capital raising and liquidity as it relates to private companies. ??Exposure to private markets was once something that was extremely limited, and although there are still significant investor qualification rules that apply to participating in some types of markets, private market exposure is becoming a much more common feature of diversified investing, and under the right circumstances, a useful asset for collateralized lending.?I wouldn’t by any stretch of the imagination say for non-institutional investors it will become mainstream any time soon, but there is certainly a growing pool of high-net-worth clients who are seeking to grow their participation in private markets.

Overview

The first thing important to recognize is that there are a multitude of ways to gain exposure to private securities today. ?Fundamentally, one has a choice of either becoming a direct beneficiary, or an indirect beneficiary. As a direct beneficiary one becomes a registered shareholder through one’s own desired vehicle. As an indirect beneficiary one acquires ownership through a nominee structure, often in the form of a fund vehicle.?

Direct Beneficiary participation creates a direct legal relationship between yourself and the private entity that you are investing in. There is an increasing number of corporate finance advisory and distribution intermediaries targeting angel investors to subscribe to private shares directly. This is sometimes alongside syndicate and venture capital investors. Direct participation will be governed by a shareholder’s agreement, which will most likely include specific provisions assigned to you when you tender for a particular share class. As such, this type of ownership structure most often restricts liquidity options and transfer rights, other than when specific events, such as increased capital raising, or an M&A transaction occur.?This type of investment approach can however carry specific benefits assigned to the share class that other investors do not receive, and can often, for the earliest participants, under the right structure, provide tax relief nearly as good as those present in an EMI arrangement.

Indirect beneficiary, or nominee structures are becoming more commonplace and are being pursued in both listed and unlisted forms. For example, qualified investors can acquire primary shares through equity crowdfunding platforms, as well as subscribe to shares through private fund vehicles that take direct position in private companies.?Sometimes these become listed as investment trusts, but often they are introduced by private asset management firms, many of whom welcome both investment in their vehicle as well as direct investment in their portfolio companies. Almost all the non-public subscription agreement that come through nominees carry some restrictive covenants that decrease liquidity options, although as we will discuss later, secondary market opportunities are emerging. ???Nominee investment will carry additional fee and charge structures, absent in direct ownership, and thus will somewhat dampen returns. ?Offsetting this is access to investments that would be otherwise unavailable, and active management engagement.

Before moving on to discuss the trends that I am seeing, and expect to emerge in private markets, it is worth briefly touching on accessing opportunities through ICOs. ??While I myself own some alt-coins, I have been a skeptic of participating in initial coin offerings.?My hesitancy is no longer a product purely of regulatory and tax liability concerns, but rather based on the poor visibility that is still a feature of many of the projects, and the spotty track record.?I have recognized that institutional participation in Defi infrastructure and application projects has been bringing additional credibility to stateside based firms that head down the ICO path, so by next year, there may well emerge a more predictable way of evaluating ICO and allowing them to be an interesting alternative investment to small cap listed companies.

Recent Trends & Implications

I would suggest that for those who want to understand the evolving landscape that one looks at the following companies, most of whom are in the US, but some are also emerging in the UK, as well as Singapore.?They are

Name??????????????????Website????????????????????????????????????????????Name???Website??????????????????????????????????????????????????????????

Forge??????????????????https://forgeglobal.com/ ?????????Harbor https://harbor.com

Moonfare ?????????https://www.moonfare.com ???????BITE ???https://www.biteinvestments.com/

Destiny (D/XYZ)?https://destiny.xyz/ ?????????????????iownit???https://www.iownit.us/

Delio???????????????????https://www.deliogroup.com/ ?Linqto???https://www.linqto.com/

FNEX???????????????????https://www.fnex.com ????????????Anduin??https://www.anduintransact.com

VALK???????????????????https://valktech.io/ ??????????????????Astrella https://www.astrella.com

1exchange?????????https://www.1x.exchange ???????????NYPPEx https://www.nyppex.com//

ADDX??????????????????https://addx.co

When I look at the evolving private securities landscape, the things which are more evident now then 3yrs ago can be highlighted as follows:

1)????A much broader variety of private securities are now accessible for purchase in some type of secondary market scenario. In some instance this has evolved in the form of a private securities exchange, while in others it is part of a broader alternative investment marketplace, where one can also acquire exposure to real estate, securitized products, and alternative funds. In these types of new marketplaces, the set-up is like the ATV that that one sees with OTC instruments.?This mechanism works by both buyers and sellers registering interest, and then the marketplace creating a secure environment to support negotiated transactions.?In this situation, buyers and sellers today are benefitting from access to more transactional and reference data than has been available previously, and thus offers improved chances of a successful outcome.

2)????Many more companies have access to SAAS based equity management platforms to facilitate more efficient capital raising, and liquidity management for all their stakeholders. Finance systems, within ERPs, have broadly had the capacity to register shareholders and capture ownership structures for a while, but equity management platforms are designed to help companies manage a variety of funding processes with both existing as well as prospective investors, and create internal markets for employee/employer transactions. It used to be the case that one had to utilize a specialist provider like SecondMarket (now owned by Nasdaq), but now venture capitalists are supporting new applications that support companies raising and managing private capital raises efforts for longer periods of time, while also providing liquidity opportunities well ahead of any transactional events to all investors.

3)????Access to private equity and venture capital funds that were reserved for investors with a minimum ability to invest at least US$5ml is being democratized. This is being initiated by asset managers who use technology to streamline the process of on-boarding qualified investors, and then efficiently managing the book-building process.?Investors who deploy capital through these vehicles do not enjoy any special privileges when it comes to liquidity provision, but they able to access fund managers who do not engage with smaller investors. Those that invest need of course to understand and appreciate what it means to be an LP and be able to provide the necessary follow-up capital.

4)????Finally, equity crowdfunding platforms have been broadening their capabilities in two distinct ways that makes them far more attractive destinations for retail clients. First, they are increasingly participating in Series A rounds when institutional clients, as well as larger angel syndicates are deploying larger capital investments. This often occurs in a “scale up” situation, and while the valuation metric is much less attractive, the risk of failure is also significantly reduced. At the same time, these platforms are developing secondary markets of their own to deliver liquidity opportunities, both for existing and prospective shareholders. These efforts are not only designed to serve the “in demand” private companies, but also organizations that are scaling up and want to broaden their shareholder base and introduce new types of capital structures on to the balance sheet.

Outlook

I am a private share investor who has enjoyed both success and outright failure through my own efforts. I have learned that the presence of professional investors often has a significant impact on the timing and opportunity for liquidity events, not to mention valuations, although even successful venture capital transactions will be failures about 2 out of every 10 transactions.

From what I am seeing the companies above initiating, sometimes with significant private investment, we are clearing entering a period of change for private markets, and one that has the potential to change the way that investors and business owners who own significant private share ownership will be treated in their personal and business affairs.?

There is a very strong change that the development of equity management systems, alongside private securities exchanges and marketplaces is going to be a catalyst to transforming both how companies undertake and manage fund raising, as well as how lenders assess individuals who have a significant interest in private companies. At present, most lenders are valuing private securities at either book value, or often an even lower tax valuation (that is depressed to help option holders), but with the way new liquidity avenues are opening and secondary markets are evolving to allow a much broader level of participation in the private securities landscape, I expect a positive evolution in the collateral landscape. I will admit that there are still some difficulties faced in terms of valuation modelling for private companies, but with the growth we are seeing in the transactional landscape and the increasing availability of more timely and accurate financial data, we are about to enter a period where machine learning is going to start to play a positive role in determining valuation.

For the increasing number of entrepreneurs who above all else have had to weather the illiquidity penalty that has accompanied hard work, a new dawn is already on the horizon.