From stocks, to bonds, to commodities and more, most investors are familiar with the various options when it comes to investing in the public markets. But what about private secondary markets? What makes buying secondary shares of private companies different from what happens every day on the New York Stock Exchange?
At the very highest level, a secondary market is one in which investors trade existing shares of a company. The proceeds from these sales go to the selling investor, not the issuing company. This is in contrast to primary markets, where companies sell shares directly to investors, as in an IPO. Secondary market transactions do not involve the creation of new shares and do not serve to finance the company. Rather, secondary transactions are a means for shareholders and outside investors to buy and sell previously issued shares. Share prices in primary markets are fixed (e.g., an IPO offering price), while share prices in secondary markets fluctuate with supply and demand.
Private Markets, Private Shares
When startup employees want to sell some of their equity and investors want to invest in private companies before an IPO, they meet in the private secondary market. This is the market in which EquityZen’s marketplace operates.
Startup employees are often awarded stock in the company as a key part of their overall compensation package. The employee’s shares may be quite valuable, but these shares remain an illiquid asset until the company goes public or gets acquired. Perhaps the employee wants to buy a house or finance another expensive venture - what are they to do with company stock that is of no immediate liquid value? If the employee’s stock has vested (i.e., they have earned the right to fully own it), they may be able to sell it to an investor eager to acquire the company’s stock before it goes public via a private market secondary transaction.
EquityZen facilitates these transactions by providing a platform for shareholders and investors to connect and the logistical support needed to facilitate the exchange.
For an investor looking to acquire pre-IPO equity in a company, secondary markets present a unique opportunity, one that was previously only available to institutional investors and the ultra-wealthy. In exchange for cash, an investor can walk away with shares in a company that, post-IPO, may be worth quite a bit more than the cost of their original investment.
On the other end of the transaction, for a shareholder looking for liquidity or diversification, the theoretical future value of stock in a pre-IPO company may not be worth as much as some immediate amount of cash.
With the right kind of facilitation, this exchange is mutually-beneficial for both parties.
What’s Next for Secondary Stock Markets?
Since the end of the Great Recession, secondary markets have been growing rapidly. One reason for this is the fact that U.S. companies are staying private longer. According to McKinsey and Company, the average age of U.S. technology companies that went public in 1999 was four years. By 2014, that average was 11 years. Meanwhile, private investment in U.S. technology companies has boomed, giving rise to the “decacorn” (privately-held startup with a valuation in excess of $10 billion).
Broad access to the secondary market is a relatively new development. As noted in a 2018 Stanford University study: “The pre-IPO marketplace has traditionally been dominated by networks of venture-capital firms, private placement agents, brokers, and banks. These markets have historically been fragmented and opaque, severely limiting access and transparency for potential investors. In response to the trend of companies staying private longer, a number of secondary private-company marketplaces have evolved to facilitate transactions between employees or early stage investors wishing to liquidate a portion of their holdings and qualified buyers.” This opaque, fragmented and exclusive market is what EquityZen was built to change.
The advent of pre-IPO secondary marketplaces have provided “everyday” accredited investors with previously-unavailable access to private companies. As companies stay private longer and are worth significantly more when they do finally go public1, it is reasonable to expect that this access will become an increasingly valuable asset for savvy investors.
There is a tremendous amount of value locked up in private, pre-IPO companies, and secondary stock exchanges are unlocking that value. Curious where to start? Check out our Guide to Investing in Pre-IPO Secondaries.
Sources:
1. https://www.statista.com/statistics/914614/median-valuation-before-ipo/
