TechCrunch - The rise of retail investors in secondaries, and why delayed IPOs will become the norm
The discussion focuses on the growing importance of secondary markets as a means for private companies to provide liquidity without going public. Jared Carmel, a secondary market expert, explains that the slow IPO market has led to an increase in secondary transactions, allowing companies to stay private longer. This trend is supported by platforms like EquityZen and Forge Global, which aim to democratize access to private investments. However, Carmel warns of the risks involved, particularly for retail investors who may lack the necessary information to make informed decisions. He emphasizes the need for institutional-grade infrastructure to support this evolving market.
Carmel also highlights the challenges faced by companies and investors in the secondary market, such as the complexity of deal terms and the lack of transparency. He notes that while secondary markets offer a pressure relief valve for companies, they also pose risks due to information asymmetry and the potential for retail investors to be misled by hype. The conversation touches on the potential for secondary markets to become a major component of private market finance, especially as the number of unicorns grows and IPOs remain scarce.
Key Points:
- Secondary markets provide liquidity for private companies, allowing them to stay private longer.
- Platforms like EquityZen and Forge Global are making private investments more accessible to retail investors.
- Retail investors face risks due to information asymmetry and complex deal terms.
- The slow IPO market has increased the importance of secondary markets.
- Institutional-grade infrastructure is needed to support the growth of secondary markets.
Details:
1. 🎙️ Introduction to the Episode
- The episode focuses on the business of startups, with a specific emphasis on secondaries in the tech world.
- Industry experts are brought in to provide insights into current trends.
- This format allows for an in-depth exploration of significant topics affecting startups.
- The experts' insights provide listeners with a comprehensive understanding of the secondary market within tech startups.
- A brief overview of the guests and their expertise would enhance the context and transition into the main topics.
2. 📊 Rise of Retail Investors in Secondaries
2.1. Retail Investor Activity and Platforms in Secondary Markets
2.2. Risks and Implications of Increased Retail Participation
3. 🔍 Slow IPO Market and Secondary Market Dynamics
3.1. Increased Secondary Market Activity
3.2. Future of IPOs and Market Predictions
4. 🔧 Institutionalizing Secondaries: A Background
- Jared Carmemell, a founder of Manhattan Venture Partners, has been a pivotal figure in institutionalizing secondaries since 2009, transforming it into a recognized asset class.
- Initially, the secondary market consisted of a small group of VCs trading shares of pre-IPO companies like Facebook and Twitter, often in a chaotic and informal manner.
- Jared foresaw the secondary market's potential to grow beyond its initial constraints and worked towards bringing structure and legitimacy to it.
- Despite early challenges, such as limited transparency and regulatory concerns, Jared's efforts have significantly contributed to the market's growth and acceptance.
- The secondary market has since evolved, with increased participation from institutional investors and a more standardized approach to trading shares, highlighting its maturation into a legitimate financial sector.
5. 💡 Understanding Secondary Markets and Liquidity Challenges
- MVP was founded in 2014 to institutionalize the secondary market asset class, standardizing it to match the mature LP secondary market. This effort is crucial as the secondary market gains traction.
- The increase in secondary market transactions is fueled by retail investors and companies delaying IPOs, resulting in liquidity issues.
- Companies now take an average of 12-14 years to IPO, causing venture capital portfolios to face liquidity challenges and bloat.
- The venture capital asset class's substantial growth presents a rare opportunity in the secondary market, characterized as a 'one in a generation' chance.
6. 🔗 Keeping Companies Private: The Role of Secondaries
- Mature companies, nearing 20 years old, remain private as the IPO market faces periodic closures.
- The secondary market acts as a pressure relief valve, providing liquidity and allowing companies to stay private longer.
- Secondary markets offer shareholders of private companies the opportunity to sell their shares, thus providing liquidity without necessitating an IPO.
- By enabling liquidity through secondaries, companies can avoid the pressures and costs associated with going public, maintaining strategic focus and operational flexibility.
7. 🏢 Why Companies Prefer Staying Private
- Companies aim to stay private longer to perfect their business models without the disruptions that public status may bring. This strategic decision allows them to avoid the penalties associated with shifting focus or making changes as a public entity.
- Liquidity needs are met through secondary shares, which do not go directly to the company. A strong foundation and sufficient liquidity are essential for these companies to grow effectively while staying private.
- Public companies often face pressure from activist investors, which can force changes that may not align with the company's long-term strategy. This pressure is a significant reason why companies opt to remain private longer, as it allows them to maintain control over their business strategies.
8. 📉 Liquidity Pressures and Secondary Market Solutions
- The average age of tech companies going public has increased from 3-4 years in 2000 to 13 years in 2021, with forecasts suggesting it may reach 17-20 years when the market reopens.
- Secondary markets provide essential liquidity solutions, acting as a relief valve for the capital stack of companies.
- Employees who leave companies often face liquidity challenges due to stock options, which can lead to significant tax liabilities upon exercise.
- Restricted Stock Units (RSUs) present further challenges in real-time liquidity and tax planning.
- Secondary market solutions, such as private share exchanges, help alleviate these issues by offering a platform for employees and early investors to sell shares before an IPO.
9. 🛠️ Retail Investors and Market Accessibility
- Restricted Stock Units (RSUs) can become worthless if not converted through a liquidity event such as an IPO or major fundraising, presenting a risk for retail investors relying on these for financial gain.
- Databricks' strategy of raising billions was aimed at covering tax bills and providing liquidity to early employees, illustrating a model for companies to support their staff financially before going public.
- Venture funds often encounter DPI (Distributions to Paid-In Capital) problems, meaning their returns are heavily reliant on one major success, which can exert pressure on companies to create liquidity opportunities for investors.
- Founders face significant pressure from investors and employees seeking liquidity, which can lead to premature public offerings, affecting market dynamics and investor strategy.
10. 🔍 Information Asymmetry and Investment Risks
- Retail investors now have increased access to the secondary market through platforms like Yahoo's partnership with Equity Zen and Forge, which provide real-time private data and lower investment minimums of $5,000, facilitating easier entry for accredited investors.
- These platforms integrate trading access, simplifying the investment process and potentially expanding the investor base, as inflation may have increased the number of accredited investors despite unchanged accreditation criteria.
- While these tools democratize access, they also expose retail investors to risks similar to gambling, emphasizing the importance of informed decision-making in this asset class.
11. 💼 The Complexity of Private Market Investments
- Private market investments include complex provisions like rights of first refusal, complicating transactions as they allow existing investors or the company to purchase shares before outsiders.
- Technology platforms aim to streamline private market transactions but face challenges such as informational asymmetry, making it difficult for outside investors to fully understand the company's financial situation and risks.
- Hidden risks for investors include new funding rounds with liquidation preferences or participating preferred shares, which can significantly affect investment outcomes.
- Investors often buy into private companies for social status rather than solid investment reasons, leading to poor decisions and potential financial loss.
- Relying on the presence of well-known investors as a shortcut for due diligence is risky, as retail investors may not fully grasp the complexities involved in these deals.
12. 🌐 The Evolution and Future of Secondaries
12.1. Transparency Challenges in Secondary Markets
12.2. Investor Challenges and Misguided Investments
12.3. Need for Improved Access and Understanding
13. 🔄 The Dynamics of IPOs, Liquidity, and Market Trends
13.1. Impact of Social Media on IPOs and Secondary Markets
13.2. Evolution of Secondary Markets
13.3. Investor Strategies and Due Diligence
13.4. Recommendations for Investors
14. 📈 Wall Street's Growing Interest in Secondaries
14.1. Secondary Market Challenges and Retail Investor Barriers
14.2. IPO Market Drought and Historical Comparisons
14.3. Implications for Companies and Wall Street's Strategic Moves
15. 🏦 Expanding Opportunities in the Secondary Market
- The secondary market is evolving and now includes strategic initiatives like tender offers, beyond just providing liquidity to founders and initial investors.
- The CLA IPO was expected to be $1 billion, but a $10 billion need emerged on the data brick side, showing a significant demand for infrastructure investment.
- Investment firms, such as Goldman Sachs, find running tenders more profitable than traditional IPOs, showing a shift in market strategy.
- Major firms like Blackstone, Apollo Global Management, and KKR have launched funds targeting retail investors, indicating growth in the secondary market.
- There are now 1,200 unicorns compared to around 100 in 2009, expanding the addressable market for secondaries, as these companies stay private longer.
- Secondary venture and mutual funds are addressing the liquidity gap for these private companies, showing a strategic shift in investment.
- The rapid capital movement in the US suggests imminent development of infrastructure for venture capital-style investment banks and private equity firms.
16. 🔮 Future Trends and Market Predictions
16.1. Secondary Market Pricing Trends
16.2. Backlog of Unicorns and IPO Challenges
17. 🚀 The Rise of Secondaries as a Financial Solution
- Secondaries are becoming the future of private market finance, potentially replacing IPOs as the primary clearing house mechanism.
- The growth of secondaries necessitates the development of institutional-grade infrastructure to meet sophisticated company needs.
- The secondary market is likely to continue thriving due to a decline in IPOs and M&As, with hopes for M&A market revitalization.
18. 🎧 Closing Remarks and Contact Information
- Jared Carmel is lightly active on Twitter (@MVP VC Jared) and more active on LinkedIn (Jared Carmel), offering to discuss potential liquidity needs with anyone interested.
- Listeners can find the podcast Equity at @EquityPod on Blue Sky and Eggs platforms.
- Equity is produced by Terresa Lokan Solo with editing by Kell, and the TechCrunch audience development team was thanked for their support.