David Frank
Forge CEO Kelly Rodriques is hellbent on dominating the pre-IPO trading space. Fresh off his completed merger with SharesPost, he wants to build a tech-enabled trading juggernaut that attracts market participants with its data and clearing capabilities. With a combined order book of $12B and 1,100 transactions closed in Q3 ‘20, he’s off to a strong start.
However, his slew of competitors aren’t going to let him take the bounty without a fight.
The pre-IPO trading space is undergoing an explosion of growth while emerging intermediaries in the space compete, collaborate and innovate for market share with widely different ways of approaching the complex market structure.
Pre-IPO Market Opportunity
The number of pre-IPO companies, venture-backed unicorns with valuations over $1B, have been growing at an incredible pace over the last decade. According to CB Insights, there are 496 unicorns with a total cumulative valuation of ~$1,575B as of November 2020. To provide context, there are approximately 2,000 companies trading on the either Nadsaq or the NYSE with valuations over $1 billion. If all the unicorns were to theoretically go public at once, this number would increase by approximately 25%.
Meanwhile, the median age of technology companies going public has grown to over 12 years (2017-2019 average) compared to 4 years in 1999 according to research done by Professor Jay Ritter at University of Florida.
This incredible build-up of wealth in the private market and the longer average time to go public has increased the desire of investors and employees to have alternative liquidity options. The secondary market helps start-ups keep their “cash-poor and paper-rich” team happy by allowing them to access liquidity for life expenses (getting married, buying a house, sending a kid to private school, etc.). Options also generally expire after 10 years, and some early employees have to wait longer than that for their company to have a liquidity event. Early stage investors are also sometimes motivated to exit companies, especially when they approach the end of the life of their fund and want to demonstrate returns.
Investors are also excited to gain access to fast growing late stage companies, especially when they can’t get access to the primary funding rounds. An incredible amount of the value creation that used to occur in public companies has been held back in the private market, and a growing segment of HNWIs, family offices, hedge funds, sovereign wealth funds and institutions are clamoring for access.
Prime Unicorn Index has attempted to capture the price performance of the asset class.
Prime Unicorn Index
Given the fragmented and complex nature of the pre-IPO market, there are huge roles for the intermediaries to match buyers and sellers, structure transactions, provide market insights, create new trading platforms and assist with the transfer process.
Private Market Data
Market players leverage data sources such as PitchBook and Crunchbase to obtain information on the most recent primary round for a given company, but the most accurate information comes directly from companies. However, unlike public markets, private companies can use their discretion to determine what information they share and with whom. This provides certain players an informational advantage which tilts the playing field. Sometimes the biggest informational gap occurs between rounds when only people with access to the management team can get timely updates.
Also, unlike public markets, there is no “tape” to see a history of all the prices and volumes companies have traded at over a time series. Making matters more complex, blocks of shares from different rounds often have different liquidation preferences, causing shares from a given company to sometimes trade at different valuations. Thus, there’s often not just one price for a given company. This may not matter if a company’s valuation continues growing, but any exit below a historical priced round could have wildly different outcomes for shareholders of the same company based on liquidation preferences between different classes of stock.
The industry’s opacity increases the value of intermediaries who can aggregate the data, help make sense of it, and help close transactions.
Trade Settlement
Rodriques: “Solving trade settlement complexity is key to building a platform today. Half our 200+ team is in tech, working on systems and integrations to connect buyers, sellers and companies to execute on transactions.”
Rodriques claims Forge sources both the buyer and seller on their platform 95% of the time, but they’re seeking to build partnerships with other brokers, RIAs and other market players.
Zanbato CEO Nico Sand is pursuing a different model, purely focused on supporting broker-dealers, giving 110 (and growing) broker-dealers access to market data and flexible ticketing order execution.
“We’re providing broker dealers who aren’t exclusively focused on the space the ability to serve their clients’ interest to transact in this high growth market. We aren’t competing with them directly by only serving other broker dealers.”
Sand is also working closely with his team to improve order execution.
“Private trading markets historically operated strictly on an indications-of-interest basis, with bids and offers lacking any legal or economic recourse to parties who fail to execute on their orders once matched. Price discovery was compromised by the real or perceived notion that tickets weren't ‘real,’ and execution rates were low with buyers and sellers frequently ‘falling-down.’ To address this, ZX created the concept of a ZX Firm Order, which creates a legal and economic obligation on a buyer or seller to honor their orders once bonafide counterparties are presented. ZX Firm Orders materially improve market operations by allowing market participants to trust that bids and offers on ZX are executable.”
Special Purpose Vehicles
Buy-side and sell-side players often create special purpose vehicles (SPVs) to facilitate trades. The SPV owns the underlying shares, and ownership in the SPV can change while the SPV’s ownership of the shares remains constant. This is sometimes done to work around restricted shares (sometimes with futures contracts) or aggregate smaller investors into a larger block. The parties of these SPVs are also sometimes motivated to earn ongoing management and/or incentive fees opposed to just a one-time upfront transaction fee, but this is not always the case.
Forge was the first to offer forward contracts that were insured by MunichRe. Several years ago, this represented approximately 70% of their business, but today it represents only approximately 3% of their business. When Rodriques entered as CEO, he shifted focus to only do trades approved by companies. Now speed is the main reason some parties choose to execute forward contracts.
Hybrid Brokerage & Asset Management Business Model
Manhattan Venture Partners has built their firm by focusing on a handful of high conviction “firm mandated transactions” instead of crossing orders across a large number of companies.
Managing Partner Brad Fishman explains how they identify which companies to focus on:
“We start by asking ourselves a series of questions. What companies do we love? Who can we underwrite to a 1.5-3 year time horizon to an IPO? Where can we source the stock at the right price? What is our conviction that we can get the transaction approved without the company or another investor exercising a right of first refusal (ROFR)? This process is iterative with constantly changing information.”
Once they decide to move forward, they invest with their discretionary funds, form SPVs for smaller investors to aggregate, and act as a broker to help larger investors directly join the cap table of the company. While most intermediaries don’t also act as an asset management company, MVP has found that this approach has enabled them to be a one-stop-shop for various investors seeking access to the space.
They were early to initiate private market coverage on many of the earlier generation of pre-IPO companies such as Facebook, Twitter, Square
Joseph Hasselmann is also pursuing a hybrid business model, having spun out of Forge’s institutional trading desk recently to form Invicta Growth as an asset management firm and Conflux Capital as a brokerage firm.
Company Liquidity Programs
Over the last 7 years Nasdaq Private Market has built a sizable business partnering with private companies to help them conduct liquidity programs for their employees and investors. Instead of continuously attempting to match buyers and sellers like other intermediaries, the firm is focused on running liquidity programs at specific times with companies (while building relationships with management teams that may ultimately list on Nasdaq). They pitch that their experience and technology can help companies minimize the costs and distractions of running liquidity programs themselves.
Since inception the firm has supported liquidity programs involving 44,230 shareholders at 257 private companies, and in the first 6 months of 2020 the firm facilitated 29 private company-sponsored secondary transactions with a total transaction value of $1.7 billion.
Eric Folkemer, Head of Nasdaq Private Market: “As more transaction activity on our platform resumes following the initial months of the pandemic, we expect the secondary market to grow, providing more opportunities for private companies and their shareholders to access liquidity.”
Nasdaq Private Markets isn’t the only group chasing company liquidity programs. Scenic Advisement CEO Barrett Cohn is also very focused on aligning with companies, seeing a sweet spot of activity to match company sellers with their institutionally focused coverage universe of approximately 700 buyers.
Seeing an opportunity to gain market share, Forge is also highly active in company run liquidity programs. Rodriques thinks Nasdaq Private Market often leaves value on the table by offering shares at a discount to a prior round opposed to leveraging capital markets data with more open price discovery to maximize share price.
Cap Table Integration
Carta is leveraging its market leading position helping companies and investors manage their cap tables, valuations, investments, and equity plans as a trojan horse to build CartaX as a vertically integrated trading and transfer company. The company promises to enable firm orders, set participation parameters, and provide efficient same-day settlement as a one-stop-shop. The firm requires that participants interface with them through a Carta broker account, potentially causing other advisors or brokers to hesitate before sending their clients to transact through them.
Rodriques believes CartaX has delayed ramping up quickly because they lack the ability to support closing transactions at scale. He projects that it’ll take them 2-4 years to catch up to Forge, but Carta is known to be a very fast moving and ambitious company.
While Rodriques wasn’t yet ready to provide details, he is excited to announce partnerships with leading cap table companies. He believes companies will insist that cap table companies open up their systems with open APIs, but only time will tell.
HNWI Opportunity
Forge is equally focused on institutional and HNWI investors, with over $13 billion in assets under custody and over 1.3 million accounts. Rodriques believes this will enable them to offer their clients the ability to lend against their shares and offer other products and services in the future.
EquityZen is a sizable competitor in the HNWI segment of the market, reporting to have closed 15,000 transactions on over 250 companies. Some have compared their platform to the Robinhood of private markets.
Others such as Cohn question if this asset class is suitable for many of the HNWI investors entering the asset class.
Emerging Players
The marketplace is full of emerging market participants seeking to build new businesses. Idan Miller’s Unicorn Exchange is building a technology-enabled platform for brokers and direct buyers/sellers to share deal flow on a white label basis using a secure smart permissions system and dynamic profiling algorithms. Rainmaker Securities has assembled a platform of entrepreneurial bankers active in the space. Andrew Kline, David Hartzell and their team at Park Lane have leveraged their historical relationships from their work in the sports and technology space to form a specialty niche business in the pre-IPO space. Ken Smythe, historically focused on raising capital for hedge funds, PE funds and direct deals, decided to focus all his energy on the pre-IPO space with his new firm Next Round Capital Partners after recently departing Artist Capital. Other entrants include InvestX, Liquid Stock, NYPPEX, Pre IPO Swap and ClearList.
The Big Banks Should Not Be Underestimated
We’re likely to see many of the larger banks form or expand groups focused on the pre-IPO space. Andrew Tuthill recently left Forge and now serves as Head of Private Markets at J.P. Morgan. BTIG, UBS and Morgan Stanley
Convergence With Public Markets
Ultimately, the pre-IPO trading space will be dominated by the platforms that can most seamlessly mirror many of the functionalities that we take for granted today in public equities: price transparency, deep liquidity of buyers and sellers, and seamless clearing. The gap between private and public markets will continue to converge as intermediaries compete for market share through innovation and collaboration.
The winners aren’t yet obvious, but it’s clear that many want to put their hat in the ring.
Author David Frank is the CEO and Founder of Stonehaven which serves as the FinTech broker dealer platform for Park Lane, represents Manhattan Venture Partners, and may be active in other areas of the pre-IPO space.
