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. 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 liquidated.
As reported by Forbes, in 2002, transactions in private equity’s secondary market were worth $3 billion.
The private secondary market has experienced rapid growth in recent years, with $49 billion raised in 2016 by secondary funds, vehicles that specialize in investing in this market and the volume of secondaries transactions reaching around $58 billion in 2017.
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. 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. 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 platforms, each of which has its sale and investment models.
The uniqueness of The Elephant Platform is that it concentrates its efforts in finding a liquidity solution for “small” shareholders 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 pre-IPO portfolios still remains a privilege of very few people.
Pressure for Liquidity
While Initial Public Offerings (IPOs) were once the natural exit for companies after a few years of operations, the dynamic has changed towards longer tenures as private companies. 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. The abundance of capital (and high valuations) in private markets, the costs of becoming – and maintaining – a public company, analyst scrutiny, the changes in regulations allowing more shareholders before listing, increasing the number from 500 to 2,000, and giving access of more investors to private companies under the JOBS Act and the rise of alternative liquidity solution are all part of the reasons for this. As the timeline has extended, the question of when a company will go public and what that company looks like at the open has become increasingly relevant to pre-IPO investors and employees.
As time to liquidity only increases, the holders of shares of such companies seek 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.
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.
Even after we solve the illiquidity problem of the original shareholder, investors that step into their shoes and want to liquidate their investment, cannot easily sell their interests 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. Essentially, it also means that aside from being extremely illiquid and opaque, it may not be easy to analyze as an investment.
The Elephant proposes to overcome the challenge in the secondary market of private equity, by adding elements to its existing Dedicated Vehicle Work Model (as described in Section 1.4 above) 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 shares of private companies through Dedicated Vehicles whose equity is represented by digital tokens.
Key, however, is that the platform records, issues and validates the sales all in a single go. At a later stage, the Platform may set up its own network or use another network for the Platform and replace the Ethereum network.
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.