Private Market Structural Challenges

Private Market Structural Challenges

Capital Markets are Evolving

The Private Capital Shift

But while the structural opportunities appear largely the same, the underlying dynamics of the global capital market are evolving. We see this manifested in the global decrease in mid to small cap securities offerings and the growth of the $1bill+ megadeals. From peak to trough, the current US market has seen a dramatic reduction (81%) in the number of IPO’s per year when compared to the mid 1990’s. Even when looking at broader time periods, IPO’s per year in this important global market have still reduced by approximately half in this decade when compared to the 90’s as a whole. However, as identified by public research from Vanguard, the headlines mask the important trend that the sharpest reductions have been in the small and micro-cap market space.

While the public market has slowed, the last 20 years has seen the private capital market has grown at more than twice the speed of its public counterpart as it soaks up deals and companies that previously would have contemplated a public securities offering. According to Bain & Company, this trend shows “no slowdown in sight”.

When speaking at the inaugural Security Token Summit in Sept. 2018, David Weild, a former vice chairman of the NASDAQ, confirmed this view when asserting that “…our (conventional) capital markets are not designed to support small issuances.”

EY, in their May 2017 analysis of US capital markets, makes the case that private capital has to a large extent filled the gap highlighted by Mr. Weild, but the question remains as to how efficiently it has done so – this large and sophisticated market is overwhelmingly comprised of paper-based instruments being entered into between peers. These investments lack the efficiencies offered by digitalization and the new features that electronic instruments in a global market can provide.

Structural Challenges

Transactional Friction and Liquidity

Prof. Aswath Damodaran, widely cited valuation expert from NYU’s Stern School of Business, makes the assertion that regardless of business type, private companies suffer from a 20-30% valuation discount due to the illiquidity of the private equities market. While this discount level generally applies to formal valuations (such as those determined when raising capital), owners of illiquid private securities often pay a larger sellers-penalty when trying to sell interests in all but the largest and most well known private organizations.

Investor Rights Enforcement

In Hunit’s view, investor rights enforcement is due for a big update – regardless of the investment instrument (private or public). Investor rights in even the highest quality securities are called upon in a proactive, costly process where legal representation is retained, a lawsuit pursued and a decision is adjudicated.

In the best cases, this process takes time, capital and resources for what can be an uncertain outcome. If the investment instrument itself or assets backing it have contact with poorly functioning judicial systems (such as those found in many countries in the developing world), the risk associated with poor investor rights enforcement is multiplied.

From the beginning of our development, Hunit’s aim has been to provide the global financial industry with a phase change in how investor rights are committed, recorded and enforced. Read more about our platform and technology.

Increasing Litigation Risk

Investors aren’t the only stakeholders that are being poorly served by today’s model for managing investor rights. In the large majority of cases, accessing a global financial market via a securities issue (equity or debt) requires the issuer to submit to the legal jurisdiction where their exchange is found. A consequence is that the issuer then loses the ability to regulate its relationship with its investors (as would be possible under a binding shareholder agreement for example), instead relying upon the full breadth of the corporate legal codes applicable to its listing.

As research about the US securities market demonstrates, the major financial markets often offer investors a broad spectrum of available legal action, many of which can be (and sometimes are) used in an abusive or disingenuous manner. As a result, the trend is towards companies seeking to stay private longer or reprivatize if possible. This forces issuers to accept the drawbacks of the current, paper-based private market as, inconvenient as they may be, they represent the more desirable option in comparison to a public securities issue.