Is Henry Ward Right?
In an article posted yesterday on LinkedIn, Carta CEO Henry Ward presented his reasoning as to why Carta-X (Carta's Secondary Market Platform) ultimately failed to gain traction. The three core axioms of Henry's reasoning were: 1. In order for a marketplace to exist, you need price discovery and liquidity. 2. Private Companies don't want liquidity in their stock, due to challenges that secondaries can pose when raising primary capital, and the impact that secondary pricing can have on employee options. 3. Companies want to "set the price" instead of allowing an efficient market to set the price for them (like in Public Markets). As a result of axioms two and three, Henry concluded that axiom 1: (an efficient marketplace with price discovery and liquidity for private assets), cannot be achieved.
On points two and three, Henry is absolutely right. For private VC backed companies today, the cons outweigh the pros of creating a liquid secondary market directly in their stock. Additionally, private companies, and VC/PE investors, can benefit from market inefficiency when setting prices. Efficient price discovery is a fundamental challenge to the thesis of seeking Alpha and generating returns in private markets. However, to conclude based on Carta's failures that private market liquidity cannot be achieved is fundamentally flawed.
There are two simple reasons why an efficient secondary market for private assets eventually will exist. 1. Individual investors want access to private investments. 2. Retail investors have a higher demand than institutional LPs for liquidity. The two main challenges that need to be solved to effectively create this marketplace are investment product innovation (to allow for access and lower minimums and liquidity) and mass distribution.
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One area where Carta went astray was not properly defining why secondary liquidity is important, and to whom. Liquidity is incredibly important to individual investors, much more so than to institutional LPs, who are constructing portfolios with a focus on long term outcomes. Coincidentally, the macro-economic shift in the fundraising environment caused by a slowdown in private market allocation from institutional LPs, coinciding with an increased recognition amongst GPs/Issuers that individual investors hold about 1/2 of global wealth, has forced issuers and GPs to pay a lot more attention to the demands of retail investors when structuring products. Individual investors can also be a better source of primary capital relative to institutional LPs, as they generally have less leverage around pricing and voting rights (control). As a result, GPs and issuers have started to structure products that are both more liquid and more accessible at lower minimums for individual investors, while still providing exposure to illiquid underlying assets. Products like interval funds, which have become very popular amongst RIAs), trade-able SPVs, and other closed end funds like Destiny (D/XYZ) are all exciting examples of product innovation enabling access to private assets at lower minimums through more liquid wrappers.
Unfortunately, product structuring is an area where Carta never really innovated, and this was ultimately due to a lack of incentive to do so. Alan Vaksman of Launchbay Capital commented as much on Henry's post, pointing out that Carta's role as an admin business (cap table management software) had incentive misalignments with the traditional roles of a marketplace or brokerage (product structuring and distribution). Simply put, Carta generates the majority of its revenue by providing cap table management software to companies and charging a SAAS fee. When Carta tried to force companies to adopt secondary liquidity and participate in Carta-X, companies became upset about Carta's ability to access their proprietary cap table data and reach out to their shareholders to incentivize selling activity. As a result, Carta became at odds with their main clients (private companies) and were pressured to shut down their marketplace business. In the same vein, fund admin platforms like Juniper Square , who have also sold their venture investors on the long-term vision of creating a marketplace for private funds, will be unlikely to do so, despite, or perhaps exactly because of, the access they have to underlying proprietary private fund data in their role as a fund administrator.
Looking to history, the first-time retail investors had access to public markets was through pooled investment vehicles (mutual funds), that allowed investors access to companies through a more flexible and liquid investment structure at lower minimums. Over time, individual stocks became available to investors and in some cases are even available today for $1 or less through fractional share ownership. Many companies ( OpenVC , Arrived , Yieldstreet , Destiny (D/XYZ) ) are structuring products that make private assets more accessible to individual investors, however, without mass retail distribution at a low cost, products made available to retail investors will continue to be subject to adverse selection bias (ie. lower quality investment products). In order to attract high quality issuers to the individual investor channel, distribution needs to be low cost and efficient. Driving down the cost of distribution comes from both standardizing workflows (where companies like Carta or Sydecar will continue to play a role), and from tapping into broad distribution networks like brokerages or the RIA channel. Traditional brokerage platforms are an exciting distribution channel through which private issuers/GPs can raise capital, with millions of captive individual investors with trillions of dollars demanding access to private markets.
Whereas Carta may have set out to solve access and liquidity for private company investing, they ended up solving a software problem (cap table management) for issuers. If Carta had remained true to their goal of providing access and liquidity to private markets, they would have evolved to focus on structuring products or solving for individual investor distribution, neither of which ever seemed to be a core focus of the company. Carta never really innovated on product structure or distribution, and as such, was unable to create a true marketplace. Cap table services become commoditized without the network effect of a marketplace, which poses a long-term threat to Carta's business. Ultimately, Henry's conclusion that a private secondary market will never exist is wrong, although he is right that Carta is not the right company to build it.