The value of intermediaries in Private Markets and how to choose one
Venture Capital Cross — 5/24/2024 — The masses are starting to get exposed to Private Markets, with sites like Notice.co offering a free data rich platform for users. However, most of these new users are not familiar with market mechanics and can often fall into common traps, we want to elaborate here in a short article. Private Markets are exciting but also risky, as it tends to be a one-sided market where there are all buyers or all sellers. Many investors who made investments during the 2020- 2021 peak are still underwater in their investments.
The value of intermediaries
Since shares in private companies are not traded on an exchange, intermediaries provide a lot of value including but not limited to:
- Price discovery
- Counterparty identification
- Settlement
- Recordkeeping
That may not sound like much, but imagine your situation if you are an employee of a Unicorn and have shares to sell, you don’t know who to sell them to, or how to settle the transaction? Registered Representatives of Broker-Dealers are specialized in this type of transaction and follow FINRA guidelines for transacting in private companies. Secondary market transactions are a mix of investment-banking and trading, it’s not a Private Placement as the seller is getting the proceeds, not the issuer. In a primary financing round, the company gets the funds raised – in a secondary market transaction, the seller of the shares gets funds raised.
Buyers and sellers don’t always agree on price, and this can lead to friction. Cultural differences and other factors, not forgetting big Egos and busy schedules, can cause unnecessary friction between buyers and sellers. This is absorbed by the brokers – blame the broker!
Counterparties should have as limited contact as possible. Good brokers prepare documents, remind both sides about timelines, deadlines, or other action items, and keep good records. KYC checks, ECP verifications for forwards, accredited investor checks, and other important compliance items are routine for a broker-dealer but not for most investors. In many cases, using a broker to negotiate a price on your behalf can result in a net better price including the broker’s fee. That’s because they see the market and have specific access to liquidity networks, beyond the obvious public retail sites.
But the secret of getting the most out of your broker is finding one you like and being exclusive to them, here’s why.
The virtue of being quiet
Imagine you want to buy shares in Groq, and you work with 10 brokers. You want to invest $1 Million in the company, and you give that indication to those 10 brokers, thinking that you will get a better price. Consumers have this ingrained into their behavior patterns, when you shop a price over a large number of stores, you can find the best possible price. But with private markets, over shopping can change the price, typically not in your favor – here’s how.
Your 10 brokers may be speaking to the same single potential seller. That seller is now approached by 10 brokers with a $1m indication not knowing it’s the same buyer. To make this even worse, some brokers will outsource that to other brokers, thus creating a multiplication effect, where 10 brokers talk to another 20 brokers who then can speak to another 40 brokers and so on, each representing the same order. When buyers are rare, such as during market downturns, this effect can be multiplied.
When the single seller in the market sees the $10m – $40m in demand, he may raise the price, he may pull the offer altogether. Whatever is his response, he’s probably not going to lower the price, which is what the buyer wants. A noisy broker can literally ruin transactions, create negative price slippage, and have other deleterious effects (i.e. time wasting). There’s no upside. Private markets are dark and anonymous, so intermediaries need to be careful how they approach potential counterparties. There are many other examples where discretion is required, consider this:
A buyer on the cap table of Company XYZ wants to purchase more shares in the secondary market. If that order is given to a broker who doesn’t know the name of the counterparty, how do they know not to approach the buyer, and ask them if they are a seller? There is a solution to this known as reverse/blind solicitation, where the broker doing the job actually doesn’t know the name of the buyer. They rely on their team to verify the buyer, but they actually don’t know the name. If they by chance reach out to the buyer, and ask them if they are a seller, no harm is done.
Many counterparties in the secondary market do not want the market to know if they are a buyer or a seller, not for reasons of confidentiality, but because they are afraid it may spook the market, or have unnecessary positive consequences, making their price higher. In either direction, there’s a process of information disclosure that is managed by the issuer or the brokers. After a successful primary financing round, a press release is typically issued naming the lead investor and other significant investors.
There are a number of good brokers out there, but far more ‘toxic’ brokers that will kill the deal and/or overcharge on fees. It’s not difficult to sort the good from the bad, just ask around, read reviews, do your research. Just like you do research for an investment opportunity, do your research on an intermediary. Once you find someone you like, who you trust and feel good energy from – stick with them! We pride ourselves in quality, not quantity – in ethics, not size of profits. We aren’t saying that we are the only good broker out there, we are leaders in the “Ethical Broker” movement, which is part of a larger movement on Alt- Wall St. which is where there is a win-win created in our transactions. The reason we focus on late stage secondaries is because of the high quality of the companies. Sellers are either employees getting a liquidity check to buy a house, or an early investor realizing a good Nx return and sending their LPs a check. Buyers, or investors, are getting access to companies that typically outperform public markets, when looking from a Macro perspective.
How to choose one
Brokers are not hard to find, but how to find an objective one? On the surface, an independent agent is the least likely to have a conflict. A broker that represents and exclusive product, or platform, has an obvious conflict they will pitch their deals ahead of others. Venture Capital Cross has an any and all policy meaning we want to find the best terms, not from a certain channel nor do we have proprietary products. There are many independents out there, with a similar model – and we are suggesting to trust your judgement. When meeting new people, are they givers or takers? Or in other words, are they asking you to do something, or they are offering to do something for you? Are they registered with FINRA and a member firm? What is their experience, track record, do they have any negative disclosures or other information that might cause pause? There are a number of factors you should consider when selecting a broker including:
- Expertise on the market you are interested in (A broker familiar with Bytedance may be different than one with experience with Anduril, for example).
- Positive feedback based on research you do and reviews
- Positive / clean FINRA broker check https://brokercheck.finra.org/
Venture Capital Cross is a cloud-portal building the macro paradigm of Private Markets with a 100 year vision.