Private stock exchanges is a popular topic for this blog (after all we have as well put together a business pitch for a platform as early as 2009; scroll to the end of the post for the link). We can’t help but revisit the topic as this new disruptive technology starts to gain acceptance, something that will rapidly revolutionize financial markets (and generate some good profit for their users and shareholders….). A long awaited useful tool for investment professionals this technology’s introduction hasn’t been easy and still has ways to go.
One of the earlier platforms, Secondmarket, was developed by a young M&A professional facing a common frustrating feeling among investment bankers that try to shop around large amounts of illiquid investments. It is however the trading of private stocks such as those of facebook that helped attract attention to Secondmarket as well as Sharepost; one more sign of business catching up with technologies in unintended ways. And this way, trading platforms started to become a way for private investors to tap into promising returns, once only accessible to private equities and bank clients through private placements. This has recently led SEC to investigate the valuation of securities in these placements to avoid conflicts of interest; one more indication of those platforms’ increased popularity. Other market participants such as MergerID (part of the Mergermarket/Pearson(FT) group) and Axial Market stay focused on outright sale of whole companies.
Market participants are increasing almost by the day and start attracting investor attention. GATE Technologies recently raised $3.6m of new funding from private investors. Xpert Financial, who raised $3m from famous venture capitalist Tim Draper in 2009, offers an SEC approved electronic platform for secondary offerings similar to Nasdaq. More competitors will probably appear as the market will follow the usual pattern of early product introduction: many early adopters vying to penetrate the market followed by consolidation around the fittest. At this point there’s room for all, as long as they have the necessary funding to reach sustainable operations. Existing platforms operate under different execution/membership models and focus in different markets allowing a choice of service to users, much as darkpools do in the traditional exchanges’ space.
What will be the critical success factor to our opinion is the ability to secure liquidity from both buyers and sellers, through aggressive business development and proactive communication of opportunities. System integrity and credibility is another important parameter which will develop as users and regulators become more familiar with the technology. At this point why wouldn’t regulators some day oblige financiers to execute deals through this platforms rather than offline if they are able to secure sufficient liquidity and better execution terms there (along the lines of the MiFID/Best Execution guidelines) further driving their adoption and trading proceeds?
Apart from trading in promising private company stock; there’s a compelling efficiency rational giving birth to such exchanges. Instead of wasting much of a banker’s time on market screening, cold calling, correspondence, etc, using an online tool one can minimize logistics and focus on the higher value parts of a deal (i.e. negotiating and deal structuring); keeping thus fees low and profits high. This way many more middle market deals will get done; even if don’t look that promising at first sight. There couldn’t be a better timing for this product due to capital demand from startups and mid size companies that need to grow out of the recession at the same time that are underserved by the banking system in the aftermath of the financial crisis.
Other product drivers are: increased familiarization with online trading/platforms (darkpools/online trading have changed the market landscape for traditional exchanges/brokers), increased use of social networking especially by the younger generation of professionals, globalization (in today’s world, sources and users of capital increasingly don’t reside at the same location) as well as increasing numbers of high net worth and knowledgeable investors. The latter can now bypass intermediaries through these platforms directly investing on targets. This can as well revolutionize wealth management. An interesting twist to that are platforms specializing in social investing/giving. These platforms can benefit the sizeable, at least in the US, nonprofit sector but also cure some inefficiencies and credibility problems there. Such example is the GATE Impact platform which is supported by Prudential’s Social Investments program.
Finally, but very importantly, this new technology can serve a great good to financial markets as it will increase transparency over private market transactions and provide a point or reference for finance professionals and regulators to value illiquid investments; a malady behind the latest financial crisis.
We will be following news with excitement and look forward to exponential growth for this product as well as M&A activity, especially in middle market.
You can see our views on the topic as well as the business case for one such trading platform in a presentation/business pitch we prepared as early as 2009: