How can we the financial industry support the tech industry in times of economic depression (and unlock $2T in value)

BY:? Ziv Keinan, CEO Simetria

????????Marla Sofer, Advisor, Simetria

Companies are Staying Private Longer, Leaving Investors with Untapped Liquidity?

The global IPO market faced significant challenges in the first quarter of 2023 due to geopolitical uncertainty, monetary tightening, inflationary pressure, and volatility in the banking sector. These factors dampened investor appetite and corporate confidence in new listings, resulting in a 61% drop in IPO proceeds compared to the same period last year. In such an unwelcome environment, it comes as no surprise that many companies are opting to stay private longer, or even indefinitely.?

As more large cap companies postpone or forgo public offerings, liquidity aspirations of investors, founders and employees are leery. The number of global unicorns is at an all-time high with over 1,200 private companies currently valued above $1 billion. In 2015-2016, we saw a similar rise in the number of unicorns due to a slowdown in IPO activity.

"The single most significant development in securities markets in the new millennium has been the explosive growth of private markets."? - Former SEC Commissioner Allison Herren Lee

With the increase in the number of private large cap companies, liquidity solution providers in these markets are experiencing a surge in activity. Unfortunately for investors seeking liquidity, most of these providers operate on slow, manual, inefficient systems and leverage unscalable processes. This manifests in bottom line EBITDA of those markets and the valuation those markets are traded at on the stock exchange and in private secondary markets.

For Private Secondary Markets To Be Considered a Mainstream Liquidity Alternative, The Friction of Execution Must Be Removed?????

Friction Causes Fires?

In the early days of the New York Stock Exchange (NYSE) paper trading was common practice. Traders would write down their buy and sell orders on slips of paper and hand them to runners who would deliver them to the trading floor. The state of the private markets today is not much different from those early days of the NYSE.

A match between buyer and seller may take months; once a match has been made, a single transaction can take up to a year to settle due to approvals and restrictions imposed on share transfers. This process leads to sizable bottlenecks in private markets as the lists of bid and ask orders accumulate. Market opacity causes poor matching execution, leaving investors questioning the value of their investment well beyond their decision to buy or sell.

As this plays out, early and growth investors, founders, and employees desperately seek liquidity solutions. Friction in private markets leads to illiquidity, ultimately sending shareholders to seek direct selling opportunities on the secondary market. Opportunistic buyers take advantage of this inefficiency to buy shares at steep discounts.

Though friction in private markets may create periodic opportunities, it does not benefit most investors. Buying into highly illiquid assets via transactions that take months to settle means that investors are forced to absorb high illiquidity premiums. Nevertheless, given that most corporations are private, many investors will opt to have some of their portfolio in alternative assets. In the US alone, there are 2,800 public companies with annual revenues over $100 million versus 18,000 private businesses of similar size.?

The emergence of innovative technologies such as blockchain, artificial intelligence (AI), and cybersecurity have spawned many new companies and the flow of funds from venture investors to them. The impact of these companies is already being felt. Earlier this year, for example, a start-up generative AI company was able to challenge the giant Alphabet consortium after many years of dominating the online search space.? Customarily, early investment opportunities in such companies are only available to primary institutional venture capital firms and through secondary private markets.

According to CB Insights, the nascent AI market has already produced 13 unicorns - five have joined the ranks this year. These startups are taking far less time to get to $1B+ valuations than most of their unicorn peers.

Opening the Market for Large Cap Private Companies

Digital settlement, global efficient distribution and controlled liquidity are the only viable mechanisms to improve efficiency in secondary markets for private companies.

Digital Settlement

The biggest roadblock hindering efficiency in secondary market transactions is the absence of an efficient settlement solution. The solution to this problem must be both technical and legal. From a technical point of view, blockchain ledger technology introduces a single source of truth to facilitate the required trust between counterparties and automation in the settlement process. From a legal perspective, assets may be traded off of the corporate capitalization table (cap table) through an SPV (Specialty Purpose Vehicle) or through a designated share class, all under a framework agreed with the company to minimize the friction inherent in the various legal restrictions imposed by companies intended to protect and control cap table participation.???

Blockchain offers an elegant technical solution for settlement designed to enforce a single source of truth. The process of moving assets on to digital ledgers, also called tokenization, is simple. It works roughly like this: The corporate shares are deposited into a custody account and a digital depository certificate is issued to the shareholders. A smart contract verifies that the buyer has the necessary funds in their wallet and that the seller has the corresponding shares. After verifying each side’s obligation, the two parties rapidly swap them through a process called the “atomic-swap.” The settled transaction is viewable by all parties involved, the buyer, seller, custodian, and corporation through the blockchain browser.

Tokenizing unlocks shareholder value and dramatically expands available asset allocation opportunities to accredited investors.Transactions can be settled not only between parties trading through the same market but also between different global market participants.?

Distribution?

Today’s global private markets are fragmented and siloed. Each one has its own assets and liquidity pools of investors. There are several reasons for this fragmentation. First is the advantage of localization. A private market that operates out of Israel is likely to have better access to Israeli unicorn founders than markets in the United States or Europe. The second reason centers on regulation. Each private market operates under local regulations that allow it to market investments to local investors. The third reason for fragmentation is linked to market operations: some private markets serve only those companies that use cap table solutions offered by the same vendor.???

The most desired outcome for private markets is cooperation. Coopetition is the term that describes the act of cooperation between competing companies.? When private markets engage in coopetition, where one side provides the liquidity and the other provides access to the asset, the result will be efficiently sourced liquidity, and the execution of? more trades. ?

Private markets that cooperatively adopt blockchain technology to efficiently execute and settle cross-market trades will win over markets that remain siloed because astute buyers and sellers will register where there is more liquidity available. This process will lead eventually to the consolidation of digital private markets into one global consortium of private markets, seamlessly sharing liquidity and assets.??

Empowering Companies

Company-lead secondary deals are the future of the secondary private market liquidity industry. These transactions are often referred to as tender offers or liquidity programs. Liquidity programs enable corporations to retain control over the cap table, ensuring that they determine the identity of each buyer, the amount sold by each seller, and have rights to allow eligible shareholders to participate in sale events.????

Liquidity management programs empower corporations by exposing them to scrutiny from external investors, and prepare them for future public listing.? When we developed a tender management offering tool, we discovered that while most large cap companies are not US based, popular private market liquidity management tools don’t meet the needs of companies. This led to the development of an agile solution that complies with regulations in the US as well as in additional countries.

With an ongoing liquidity solution, corporations manage their own liquidity pool by whitelisting investors who are interested in purchasing shares of the company or by tapping into liquidity of existing markets. The company can lead an auction for its shares when there is a need for price discovery and decide on pre determined trading windows.

A liquidity program not only empowers the company but can also unearth the value of equity owned by many smaller shareholders.?

A Call For Action

For more than a decade, global interest rates remained near zero or negative. No one predicted that rates would soar to current levels as quickly as they did, rattling private markets and derailing potential exit events for many founders and venture capital investors.

With the increase in interest rates, it is no longer reasonable to expect that investors will lock themselves into illiquid holdings for an average of 14 years until the company eventually goes public or is acquired.? Secondary Transactions are the most sensible exit strategy for most technology company shareholders.

The financial services industry plays a key role in ensuring that private markets operate efficiently. The economic benefits are significant. Private markets unlock $2 trillion in value for investors. To do so, markets must support private technology companies, harness? large liquidity pools, and create more efficiency in secondary market transactions. Every large tech company is a? prospective initial public offering (IPO) customer, and investing in pre-IPO companies to help stakeholders find liquidity in times of economic crisis will eventually pay off.?

Ziv Keinan is the CEO and founder of Simetria and a digital securities expert.

Marla Sofer is a fintech leader, an advisor for Simetria, Alum of BlackRock, Microsoft, J.P. Morgan, Carta | Creator, @Knomee Financial Identity?