Monark Monthly-January Edition

Welcome to the first monthly edition of Monark Monthly, a newsletter written by yours truly, Ben. Every month, I will provide analysis and commentary on current events in private markets, with a focus on the development of private market infrastructure companies, and the ever-complex movement to democratize access to private markets. For each topic, I will share a brief two-paragraph overview and analysis. Each monthly edition with generally cover a variety of random, but hopefully relevant, headlines from the month. So, without further ado, enjoy!

January has certainly been interesting so far. The past 4 weeks brought us the following headlines. The Carta Controversy, (which opened a broader discussion about the importance of incentive alignment in Pre-IPO secondary markets). Trouble with Flow (and commercial real estate generally). Arrived Homes Reg A Fund, YieldStreet's Coming for iCapital?, and Evergreen Excitement. Perhaps the most striking theme of this month is how interwoven private markets have become.

Let's Dive Right In.

The Carta Controversy

This was probably the biggest story of the month, so I will spare you from a lengthy recap of the controversy. If you don't know why Carta just exited the secondary market business, read about it here. It has become clear over the past week that CEO Henry Ward made the right move to shut down CartaX, the company's secondary liquidity platform. What is not clear is where Carta will go next. The ultimate vision of Carta was to develop a robust secondary market for shares of Pre-IPO companies, and now that this is not the case, it will be interesting to see if Carta ultimately grows into its $7B valuation. But what was really interesting about this controversy, is why it happened in the first place. The reason Carta's sales team was so aggressively pursuing private shareholders to sell their stock, and using private data to do so, speaks to broader challenges facing secondary markets in the Pre-IPO asset class. Companies generally don't like the idea that an active secondary market might develop in their stock and are worried about the implications that shares trading at a discount could have on 409a valuations, which impacts employee options pricing. In addition, if new buyers can access a company at a discount through the secondary market, it may become more difficult to raise future primary rounds at higher valuations.

These are both valid concerns for private companies, and ultimately these factors are more impactful the earlier a company is in its life cycle. It is for that reason that Republic and StartEngine have struggled to attract meaningful volume to their own secondary market offerings. However, it is also true that private companies who choose not to go public for 10-15 years, have an obligation to shareholders to provide some amount of liquidity. Adam Hardej led a very interesting discussion on this exact topic last week. Adam recently took over Sandhill Markets after former co-founders Ali and Olivier decided to leave the business. Ali cited numerous cease and desist letters from private companies as factors for why they decided to stop pursuing venture backed scale. (Sandhill Markets was also building a secondary market for Pre-IPO company stock.) Balancing the very real concerns of private companies, with the demand for liquidity from shareholders and investors is a fine line to walk. Take Space-X, who runs a quarterly tender offer to shareholders, as an example of a company proactively finding solutions to the problem of illiquidity. Ultimately, the unique nature of the pre-IPO asset class will make the development of a true secondary market difficult, but not impossible to solve. And if the Carta Controversy tells us anything, it is that a true market intermediary is necessary for building an exchange, not one that owns your private cap table data.

Trouble With Flow

This was an interesting development over the past few weeks, that speaks to the broader problems plaguing the commercial real estate market. For those that don't know, Flow is a residential real estate company built around the same concepts of community that Adam Neumann revolutionized with his first venture, WeWork. While a lot of details remain private, Flow is essentially a real estate holding company that acquires large multi-family rental buildings and turns them into community-oriented properties, charging a rent premium for the presence of community. But the recent cash flow crisis impacting two Nashville properties owned by Flow, speaks to a larger issue in the commercial real estate industry. Neumann acquired these properties in 2021 using a variable interest rate mortgage, meaning that the mortgage rate went up dramatically as interest rates rose over the past year. Commercial real estate is almost always purchased using significant amounts of leverage (debt), with the idea that cash flows from rents will cover the interest payments, and any additional revenues will become profits. Unlike residential properties, commercial real estate is usually acquired for cash flow and tax breaks, not equity appreciation. Commerical loans have between 5–10-year terms and are typically interest only, meaning owners aren't buying more equity with each monthly payment, but simply servicing debt obligations to the lender.

Here's the big challenge, $1.2T of short term commercial real estate debt comes due in 2024-2025. Operators that bought properties between 2018-2022 did so without knowledge of a massive interest rate hike, which the fed implemented to counter inflation in the economy. With multi-family interest rates still elevated above 5.2% (office is still above 6%), and banks imposing tighter lending criteria, most owners don't own enough equity to meet banks upcoming refinance requirements, nor do they have the desire to refinance debt at current rates. A lot of commercial debt is originated by regional banks, who are already under significant pressure to shore up their balance sheets after the SVB and First Republic crisis's. So, what does this all mean? Ultimately it means commercial real estate owners will either have to raise more equity, to lower their debt obligations wait until rates come down to refinance, or sell. For savvy real estate investors, the next 24 months may present some of the most opportune entry points of the next decade. Real estate operators/funds that can raise equity capital (as Flow did in partnership with Yieldstreet), to replace expensive debt in the capital stack, will find great opportunities to buy cheap equity from desperate operators facing unsustainable debt payments.

Arrived Homes Regulation A Fund

The launch of Arrived Homes Regulation A Single Family Residential Rental Fund was an exciting development in the Reg A space, as issuers grapple with the challenges of providing access for non-accredited investors. The launch of Arrived's Reg A fund was a legal triumph, as the unique structure of the fund allows Arrived to avoid designation as an investment company. Regulation A explicitly cannot be used to raise capital for an investment company, broadly defined as an entity that raises capital for the purpose of investing in securities. Arrived Homes avoids designation as an investment company by selling shares of an operating company, whose stated purpose is to originate, acquire and manage residential rental properties. KKR just avoided investment company registration at much greater scale with their Reg D emerging growth company, K-INFRA, focused on making infrastructure acquisitions. The classification as an operating company is important, as raising capital for an investment company as defined by the 40-act, via Reg A, would be a violation of the clear parameters spelled out by the SEC in the regulation. Many private issuers generally try to avoid designation as an investment company, as it creates a whole new set of 40-act compliance restrictions to adhere too.

Private markets issuers have grappled with the challenge of scaling Regulation A offerings for years, as the regulatory cost and reporting burdens make the unit economics of offerings difficult with such a small cap of $75M per offering, per year. Dalmore Group has pioneered the use of Series LLC's, used by platforms like Arrived and Rally Rd, as a lower cost solution to acquiring assets via Reg A. Series offerings allow issuers to raise capital under the same $75M offering, with separate and distinct Series LLCs owning different underlying assets. In the same vein, Arrived's new investment "fund" allows the platform to raise $75M in operating capital to deploy into a portfolio of underlying SFR properties. This innovative approach represents a potential new era for Reg A, as many issuers have struggled to generate profit from single asset offerings. One of the most prominent challenges with Reg A is that most private asset managers are not use to the robust disclosures and on-going reporting requirements of raising capital through Reg A, and as such, prefer to use Reg D to raise capital from accredited investors. Ultimately, Reg A seems to have found its niche with issuers who are willing to take a real operating role and balance sheet risk in acquiring the underlying assets, whether real estate, collectibles or private companies.

Yieldstreet's Coming for iCapital?

This week, Yieldstreet announced that they are going after the RIA channel through the launch of a partnership with Luma. Luma's platform helps advisors access structured products and annuities, and now, Yieldstreet products as well. Pulling a quote from the article linked above, “This is sort of our first big push into the RIA channel,” said Yieldstreet CEO Michael Weisz. In my 2023 end of year report on private markets, I questioned Yieldstreets unique position in today's market, operating both a d2c brokerage platform and asset management business. If this partnership says anything, it is that Yieldstreet has decided to move in the direction of being an asset manager for retail investors and will likely pursue a number of channel partnerships in the future to expand distribution.

By pursuing the RIA channel as a means of distribution, Yieldstreet puts itself in direct competition with iCapital, and the underlying asset managers that distribute product through iCapital feeder funds (Blackrock, KKR, etc). I would argue Yieldstreet has a unique advantage in targeting the accredited investor channel, as they have more experience developing products with shorter investment durations, lower minimums and some, albeit limited, access to liquidity. Both Yieldstreet and iCapital have raised over $700M in venture funding, although from very different investor bases. According to Crunchbase, iCapital raised capital primarily from partners such as Blackrock, UBS and Carlyle, while Yieldstreet raised primarily from venture funds like FJ Labs and Greycroft. The difference between the two mega-platforms investor bases provides deep insight into their respective strengths and weaknesses. Yieldstreets biggest challenge has been getting access to institutional quality managers (supply), while iCapitals biggest challenge has been downstream distribution and building scalable technology. Each platforms greatest weakness may be the others greatest strength. Perhaps a merger or acquisition is in play over the coming years???

Evergreen Excitement

iCapital announced recently that the Future is Evergreen, emphasizing their push to access accredited investors, downstream from the Qualified Purchaser market where the business started. Evergreen funds provide diversified access to private market strategies at lower minimums and enable broader access for accredited investors. Evergreen funds are classified as registered investment companies under the 40 act, which imposes a higher disclosure and reporting burden relative to private drawdown funds. Registered funds come with their own unique set of challenges, as capital is raised in an IPO format with continuous daily offerings at NAV, as opposed to private drawdown funds that secure commitments, and call capital periodically. Registered funds have greater potential for cash drag, where undeployed capital sits in the fund without generating returns for investors. As such, the current iteration of Evergreen funds has focused primarily on secondary and co-investment strategies.

Secondaries and co-investments that leverage a managers existing network of deals, allow registered funds to deploy capital faster, and minimize potential cash drag scenarios. The other unique aspect of registered investment companies is the potential for the development of a more active secondary market. In Stepstone's evergreen SPRIM fund prospectus, they write: "Liquidity in assets that are not publicly traded is a rapidly evolving area, and the Fund may seek to create opportunities for Shareholders to achieve liquidity through any secondary market, listing service or similar mechanism that may become available." Stepstone is one of the most prominent players in the registered fund space and has built out a robust secondaries business as well. Their inclusion of a clause to potentially enable access to a secondary market for shareholders, is an exciting acknowledgment of future developments in the space. Overall, evergreen funds are a step in the right direction towards providing greater access to private markets at lower minimums, and if managed properly, to outsized returns.

Thank you for reading this first edition of Monark Monthly! Feel free to leave feedback or reach out to discuss any of this month's headlines.