Background

Secondary Market

In finance, the private equity secondary market (also often called private equity secondaries or secondaries) refers to the buying and selling of pre-existing investor commitments to private equity and other alternative investment funds. Given the absence of established trading markets for these interests, the transfer of interests in private equity can be more complex, time consuming and labor-intensive.

By its nature, the private equity asset class is illiquid, intended to be a long-term investment for buy-and-hold investors. For the vast majority of private equity investments, there is no listed public market; however, there is a robust and maturing secondary market available for sellers of private equity assets.

Attractive features of private equity secondaries may include faster cash flow realization relative to primary private equity commitments, greater visibility into underlying holdings, access to more advanced companies following vintage years and lower expenses due to the avoidance of some of the fees paid by the original shareholders and/or waiting periods undertaken by such shareholders up until the time their interests are exercised.

The private secondary market has experienced rapid growth in recent years, with volume of secondaries transactions reaching around $40 billion annually since 2014. (Source: The Private Equity Secondary Market, published by Collar Capital)

This development primarily opened new opportunities for investment and increased the volume of liquidity available to shareholders to some extent. However, this concept is relatively new and is not even entrenched where it matters most; the stock exchanges and other similar institutionalized markets. Market imperfections, as such, are a norm in such a situation. Moreover, a deep-seated and efficient secondary market requires a diverse and extensive investor base.(A Framework for Developing Secondary Markets for Government Securities (EPub) – By Zsófia Árvai, Geoffrey Heenan).The kind that the current structures in the secondary market of private equity are locking out.

Despite of its advantages, private equity is a very complex class of assets; one that business literature refers to as artsier compared to other forms of investment. It is a preserve of very experienced and knowledgeable fund managers as it demands a lot more management skills as compared to other segments of the securities market. (Introduction to Private Equity – By Cyril Demaria & Private Equity in China: Challenges and Opportunities – By Kwek Ping Yong). A big part of this complexity is the fact that once you elect to step into the shoes of the selling shareholder, now you are the one that has limited liquidity and your options are limited. With the rising of the private secondary market, came also the secondary market platforms.

The largest platforms are US based, Sharespost and Nasdaq Private Markets in addition there are other significant non-US platforms, each of which has its sale and investment models.

The uniqueness of the PrivatEquity.biz Platform is that it concentrates its efforts in finding a liquidity solution for small shareholder and “small” investors and wishes to enable transactions that may be too small for other platforms, while opening this emerging investment class to many more that were shut out of it until now, even by other platforms.

Aiming our efforts at allowing access to this sector of small shareholders presents an enormous opportunity. A significant percentage of the share capital of advanced stage private tech companies is still usually held by small shareholders, including founders, former and current senior managers.

The majority of the shares currently available on our platform are listed by founders as well as former and current senior-level executives and private shareholders of the companies.

A vibrant investment platform, in any given market, is often judged by its ability to open up to additional classes of investors,  to provide additional tools and services to both shareholders and investors, to keep developing its model to allow quicker, simpler and easier execution of profit, all while staying within the given statutes and applicable regulations.

Activities in the secondary market have exposed the underbelly of the investment ecosystem; revealing two key issues;

  • Extremely long illiquidity durations; and
  • Investing in tech portfolio still remains a privilege of very few people.

Pressure for Liquidity

During the last decade, the time to liquidity for companies founded out of venture capital increased from approximately 3-5 years up to 10-12 years, and keeps on increasing. This means that companies wait longer to get listed on  stock exchanges because of 3 main factors:

  1. Public market investors prefer opting into established companies that have proven track records, even at the price of higher valuations, rather than taking a risk on unproven companies with just a “great idea or product”;
  2. The regulatory environment has became more and more strict in an attempt by the regulators to protect investors that have lost significant amount of stheir money invested in the “tech bubble” and the financial crisis. Subsequently, it became much less attractive for management of such companies to list their shares. Compliance with regulations also takes up a substantial amount of their management time and has high maintenance costs; and
  3. Companies have proven that they can raise substantial funding from venture capital and private investors that in the past were only available through the public market.

As time to liquidity only increases, the holders of shares of such companies seek for opportunities to liquidate their shares and enjoy the financial benefit from their increasing value and exercise their holdings without waiting for the long-awaited IPO or Exit to actually occur.

With our new Token Model, we provide a solution to the pressure for liquidity by using distributed ledgers of smart contracts to connect investors and stockholders, that allows them to liquidate shares available in the private equity secondary market. This does not only benefit investors that are already active in the secondary market, but it also opens up the secondary markets to many more classes of investors.

Aside from the unbridled access to the secondary market in private equity, we avail the necessary technological tools that allow investors to enter investments starting with low threshold entrance amounts and allow investors and shareholders to interact and exchange information privately in a secure and convenient environment that preserves the privacy of the listed companies’ confidential information.

Challenge

Even after we solve the illiquidity problem of the original shareholder, investors that step into their shoes and want out, cannot easily sell their share capital to other investors.

This only confirms the definition of private equity, which business literature defines as an investment activity in a private company, usually in a privately negotiated transaction.(Introduction to Private Equity – By Cyril Demaria) Essentially, it also means that aside from being extremely illiquid and opaque, it may not be easy to analyze as an investment.

Solution

PrivatEquity.biz proposes to overcome the challenge in the secondary market of private equity, by adding elements to its current Limited Partnership Work Model which are Blockchain based protocols entrenched in the Ethereum network. This enhanced platform provides opportunities for investors that want to buy or sell rights to private company shares through dedicated limited partnerships represented by digital tokens. Key, however, is that the platform records, issues and validates the sales all in a single go.

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