The New Wave in Private Securities Marketplaces
By Ivy Schmerken
With so many private companies staying private far longer than in the past, a new wave of platforms is looking to develop trading venues that allow employees and investors to buy and sell shares in a secondary marketplace.
Last February, The Financial Times reported on a booming market for private secondary transactions, describing it as an “opaque, fast-growing corner of finance” that may need regulation.
Secondary platforms including EquityZen and Forge Global, which went public in a SPAC this year, facilitate the buying and selling of shares between investors and employees who have equity in those businesses.
In addition, there are a host of independent brokers arranging transactions in private shares between hedge funds and other institutional investors that buy large blocks in private companies prior to an IPO or big acquisition, according to the FT.
New venues maintain there is pent up demand for investing in and trading private shares, which has been traditionally only available to the most affluent investors, who are deemed accredited investors.
“The growth is undeniable, the demand is insatiable, there’s been a limit on supply, and there are structural inefficiencies,” said Dan Sanders, Executive Vice President, Private Markets at InvestX Capital Ltd., who joined the startup after 25 years in the public equity and fixed-income securities market.
Eyeing this demand, major broker-dealers, wholesale market makers and global exchanges are striking deals and forming new platforms to bring automation to private securities trading.
InvestX Capital launched its GEMs (Growth Equity Marketplace) secondary market platform in 2014 focusing on late-stage pre-IPO private companies valued at $1 billion and above. It recently attracted investments from Jefferies Financial Group Inc., Virtu Financial, and Canaccord Genuity Group Inc., which it’s using to advance its technology platform, increase back-office integration, and expand its footprint into the U.S. and Canada.
Industry veterans who have spent their careers in institutional trading in stock and bond markets see an untapped opportunity to build a market infrastructure for price discovery and trading in private shares.
“Despite its growth, private equity is still in the early stages of trying to understand how to collect the information, how to get the engagement, how to move into a more transparent world,” said Jonathan, Clark, President, USA at InvestX Capital Ltd., who was formerly the CEO of Luminex, the buy-side block crossing network (which merged with LevelATS), and previously was co-Head of Trading in Blackrock’s Americas business.
Both Clark and Sanders are responsible for supporting InvestX’s growth and providing broker dealers with access to the growing private markets through the GEM platform.
The push to automate private securities trading has also caught the attention of major exchanges, which are investing in digital asset platforms with innovative technologies like blockchain.
In February, Intercontinental Exchange announced a strategic investment in tZERO, a blockchain pioneer which operates an SEC-regulated alternative trading system (ATS) for tokenized securities trading. In addition, ICE veteran team member and Chief Strategy Officer David Goone is joining tZERO as its next CEO and will serve on tZERO’s board of directors, according to a statement. ICE said it would be a “significant minority investor” in tZERO, which currently has six private securities offerings on its platform.
Originally founded by Salt Lake City-based e-commerce retailer Overstock.com, and funded by Overstock’s venture capital arm, Medici Ventures, tZERO helps issuers raise capital by supporting secondary trading through its digital security trading platform.
“We built an ecosystem that is akin to the national markets as they exist today. Users on our platform see a quote, full level II window, both bids and offers, and they could interact within our liquidity book similarly to how someone would go and purchase shares from a national market center,” said Alex Vlastakis, President of tZERO ATS.
In March, London Stock Exchange Group (LSEG) said it’s stepping into private markets by making a strategic investment in Floww, a platform that links startups with financiers. LSEG will work with Floww to help launch their private primary capital raising facility, while exploring liquidity and secondary market offerings. Floww ‘s digital platform already features 7,000 company profiles and 70 venture capital firms.
The Wealth Gap
The main driver behind secondary trading in private companies staying private for longer than in the past. “The lifecycle used to be three-to-five years, and now it’s seven-to-ten years,” said Sanders.
At the April STANY annual conference in New York, Brian Schaeffer, managing director of InvestX Capital, said companies are staying private for ten-to-fifteen years, and there are about 800 companies with a $1 billion valuation that are private today, as compared to under 100 companies about seven years ago when InvestX was formed.
“The reason for that is that there’s a handful of buy-side institutional players that get involved early in the A, B, and C rounds that are injecting liquidity and allowing those companies to stay private much longer and collecting all that alpha themselves,” said Schaeffer in a fireside chat about private markets.
Industry executives at the STANY event discussed whether the SEC would update the definition of accredited investor so more individuals could invest in private companies and in digital securities.
Schaeffer said one of the reasons there’s a widening wealth gap in the U.S. is lack of access to private markets. Only 15% of the U.S. population qualifies as accredited and hence, has access to these companies while 85% is not permitted to invest in these companies, he said. “That’s why InvestX is here to help democratize and electronify the private markets,” said Schaeffer.
According to Schaeffer, there are two separate business lines: InvestX’s investment team does due diligence and invests in private companies, then offers participation to wealth managers for distribution to their high-net worth clients. In addition, InvestX allows for block trading of private companies as well as a secondary market for the InvestX Special Purpose Vehicles (SPVs).
To lower investment minimums, each SPV invests in a single-name private company which is divided into fractionalized shares for distribution to wealth managers and the financial adviser community. “When you think of building an SPV for $25-$50 million worth, that represents one position on the cap (management) table. You can then distribute that to a multitude of individuals, accredited (investors), QIBs (qualified institutional buyers), etc., in a fractionalized opportunity,” explained Sanders. InvestX‘s past and current portfolio of SPVs includes private billion-dollar technology companies, such as SpaceX, Impossible Foods, Instacart, Varo Bank, Kraken, Palantir, and SoFi.
Tokenizing Private Securities
According to tZero’s web site, tZERO ATS has facilitated secondary trading of security tokens since 2019, after it pioneered the first reported trade of a blockchain-based security in 2016.
Currently, tZERO ATS is working with corporate issuers by giving investors the ability to trade securities issued in a private placement in a real-time marketplace with blockchain elements that provide automated, continuous trading.
“Traditionally these sorts of opportunities were exclusive to the incredibly wealthy investors and institutions that have monopolized that market. Private securities can also provide a foot-in-the-door for investors should a company decide to go public,” said Vlastakis.
“There are a number of different ways that (private) securities can become available to the general public depending on the status they are trading under,” said Vlastakis. In certain instances, someone does not have to be an accredited investor to partake in the resale of a privately issued security, he said.
“We provide the infrastructure that’s similar to more conventional equity securities and have the unique benefit of providing securities and assets that Main Street traditionally have not had access to.”
Last June, tZERO partnered with real-estate crowdfunding company, NYCE Group,” known as the Robinhood of Real Estate” to tokenize $18 million worth of the firm’s shares using TZERO’s proprietary smart contract technology, reported CoinTelegraph. Digital securities currently traded on the ATS include CURZ, representing ownership in preferred equity of the financial newsletter firm Curzeo Research; ASPN, which offers fractionalized ownership in a Colorado ski resort; EXOD, the digital security for Exodus Movement, a developer of a non-custodial cryptocurrency software platform, and MYRA, representing ownership in Spot@Myra Park, a Dallas-based real-estate development project. In addition, the ATS provides trading in tZERO’s native token TZROP and Overstock’s digital security OSTKO.
Solving the Liquidity Problem
In setting up a secondary marketplace for private securities, venues acknowledge they will address lack of research, liquidity, data, and inefficiencies in back-office processes.
“Liquidity is obviously a big issue,” said Clark, who said it’s not too different than trading small cap stocks. Today, brokers have institutional clients that are sitting on long positions in private companies. An employee of a tech company or an early round investor may want to send a child to college or buy a home but is waiting for a liquidity event. In a secondary transaction, an investor could buy or sell from an existing investor rather than buy new shares.
In the STANY fireside chat, Virtu Financial CEO Doug Cifu pointed out that although private markets are not as “fast moving, low-latency, or algorithmically-traded as others, Virtu makes markets in more than 8,000 securities and not all of them are Tesla or actively traded, such as pinks and bullies.”
The cloud-based GEM platform provides price discovery information, access to trading information and trade confirmations, offers real-time trading technology, and helps eliminate the typical long holds of private investing. It also gives clients the ability to sell or add to an investment, said Sanders. “A broker-dealer would be able to input their indications and view the transparency of where the other indications are from the multi-dealer platform perspective,” said Sanders. Brokers will see a company name, an offer price, and a bid price, resembling a Level 2 dynamic feed, he said.
Clark said the aspirational goal is to trade private shares electronically, but he expects investors to have a conversation and negotiate initially as with high-touch block trading. “Obviously, it’s not the pace of trading; there’s no NBBO and tape,” said Clark, referring to the national best bid and offer in U.S. equities. “Nevertheless, there’s a lot of opportunity to look at market data in that private realm,” he said.
Regulators Seek Transparency
The move to build private marketplaces comes as regulators call for more transparency into the private equity and private fund industry. In October 2021, departing SEC Commissioner Allison Herren Lee called for increased disclosures on private companies after arguing in a speech that “the economy is going dark,” due to the growth of companies choosing to remain private rather than list on exchanges.
To gain more insight into the $18 billion private fund industry, in February the SEC has proposed rules requiring more disclosures from the private fund industry to investors on a variety of areas including the total cost of investing in such funds, performance, audited statements, and conflicts of interest.
Those investing in private securities marketplaces say their platforms are providing increased transparency into private securities and creating a workflow solution for private securities trading.
“I think one of the advantages of InvestX is it does help augment and streamline the due diligence process around private companies,” said Virtu’s Cifu, speaking at the STANY event, adding that these platforms “are not like the wild west of trading OTC and bulletin board stocks and there are guard rails around information.” In addition, Cifu pointed out that investors will discuss investing in private securities with their trusted advisors, another safeguard.
Venues like tZERO ATS, a registered FINRA broker-dealer, claim they improve transparency and efficiency in the private securities transactions. Private securities that trade on the tZERO ATS are enhanced by focused blockchain functionality. According to tZERO ATS President Vlastakis, the blockchain functionality of these securities enables investors to gain insight into the ownership structure of the companies they invest in, which has typically not been available to the public.
He noted that the kind of transparency available offered by blockchain functionality could also be a useful tool for regulators.
“As markets mature, you will see an increase in information that is available. And as issuers come to us and have different ideas and build out the use cases for distributed ledger technology in capital markets, you will continue to see information that is going to help investors make information decisions and regulators maintain a compliant market,” said Vlastakis.
“The traditional method of consummating a transaction in private markets was burdensome and complicated. It has involved lots of paperwork. Today we created a procedure and a user experience that can do the same transaction in a second,” he said.
In February, tZERO ATS launched self-clearing functionality, which means it can onboard additional private securities at a faster pace and accelerate the settlement times of transactions on its private security trading platform. “For investors that come onto our platform. They have that added benefit of just having settlement transactions in real time,” said Vlastakis.
Since tZERO owns a retail broker-dealer subsidiary, tZERO Markets, both individual and institutional investors could open an account to get access to private securities, he explained.
“TZERO, through TZERO ATS, which is also a broker-dealer subsidiary, maintains a list of broker dealers that are subscribers to its ATS. The entire gamut of Wall Street can choose to enter our ecosystem,” said Vlastakis.
Going forward, platforms are expecting burgeoning interest in investing in and trading private securities. In addition to Nasdaq Private Markets and Forge Global, technology startups like Carta, a provider of cap management software to private companies, launched CartaX, an auction-model for private markets, and JP Morgan is backing Zambato, a private-share trading system, according to the FT.
With so many players in the field, InvestX has already assembled a broad swathe of the broker-dealer community to participate. “As big as their platforms are, ultimately you need a community of brokers who are all going to meet in one place and do business because this market is so fragmented,” said Clark. “You’re going to need a crew of broker dealer to come together and find the proverbial buttonwood tree and do business,” he said.