Home Venture Capital Quick thoughts on secondary markets in the wake of CartaX | by...

Quick thoughts on secondary markets in the wake of CartaX | by Verdure Capital Management LLC | Verdure Capital Management | Jan, 2024

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Verdure Capital Management LLC

Verdure Capital Management

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To the naked eye, two recent headlines may appear to be contradictory:

But, there is a common thread: private markets are evolving and trust among market participants is paramount.

Firstly, secondaries can mean different things to different people. In this case, Carta X (or “Ex” as some have put it) was operating as an agent, aiming to facilitate direct secondaries, trading the shares of VC-backed companies between buyers and sellers. Whereas, Lexington Partners operates as a principal, predominantly focusing on investing in LP secondaries with the target securities largely comprising alternative investment fund interests. Different business models, different incentives, and to some extent, different end markets.

The LP secondary market is massive and fairly mature, albeit still inefficient. Lexington is among good company with peers like StepStone, GSAM, Blackstone, Ardian, etc. who have raised large vehicles given current market conditions. And there are a host of renowned institutional intermediaries in this market as well: Lazard, Jefferies, PJT Park Hill, etc. that facilitate (read: broker) the transactions in a managed and discreet process. Bankers lose clients when processes break and sensitive information gets into the wrong hands.

It is also worth noting that the LP secondary space is largest among the most mature and institutional alternative/illiquid asset classes: real estate, private credit, and private equity. Each with well north of $1T in global AUM.

Venture capital is a fast-growing subset of the Private Equity asset class, but tends to have significantly different underlying characteristics — most notably, the power law driving returns among higher risk and lower profitability profiles — and this alters the nature of institutional participation in the VC secondary market.

With VC tearing at the seams amid AUM growth over recent years, the valuation whiplash post ZIRP, and limited exit options (IPOs and strategic & sponsor M&A all down significantly over past ~18 months), both emerging and established fund managers need alternative liquidity options.

More secularly, capital market innovators have sought to support the evolution of the VC asset category over the past ~2 decades. SecondMarket (RIP), SharesPost (acq’d by Forge), Forge (NYSE: FRGE), Caplight, Zanbato, Nasdaq Private Market, and numerous independent broker-dealers and top banks have pursued building various components of marketplace infrastructure. From custody to trading to equity research to data solutions.

Moreover, as companies have remained private longer, marketplace solutions gained legitimacy and usefulness, and the most forward-leaning organizations have leveraged secondary trading data for price discovery to inform primary raises and employee stock option plans.

Carta has long been considered the trojan horse poised to win. Building high-utility administrative tools hoovered up cap table data, creating a massively advantageous data graph of market participants. In theory, this data could provide the input needed to execute against the secondary marketplace holy grail, at scale.

But, here we are. Most private companies prefer being private and working with high-trust capital partners, versus being exposed to open market forces and the often-misaligned incentives/behaviors of intermediaries that go along with it.

That is, until capital market capabilities are must-have infrastructure — see SpaceX, Stripe, Canva, and many other mega cap pre IPO companies with regular ongoing liquidity programs given their scale, employee tenure, and evolving investor composition. Even still, they manage who and how buyers and sellers can participate.

It wasn’t until a major debacle with pre-IPO trading of Facebook shares that ROFRs and Board Approval mechanisms were implemented in most private company equity arrangements. This CartaX story is a similar watershed moment where market forces batter against the private market’s private-ness. Perhaps the long tail of unorganized one-off secondary transactions will grow narrower.

One of two things will happen: secondary markets will get more efficient or they won’t. The efficient market hypothesis has a strong opinion as to how this will play out. The only question is how the asymptotic force of control may change over time.

#secondaries #carta #privatemarkets

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