The Blurring Of The Public And Private Markets
Five or six years ago, as the USV team was discussing the evolution of late stage financings and secondaries on the venture landscape, our partner Albert described something to us that was, in hindsight, very prescient. He said “there is no reason why there is such a bright line between public and private markets, we should have one market where the more a company discloses, the more liquid their security becomes” (or something like that). His point was that the only thing that really matters is how much information a company is willing to disclose.
We are increasingly seeing what Albert described to us come to pass. The ability to raise large sums of capital from public market investors has been available to privately held companies for a number of years now. There is no real difference between the public markets and the late stage growth markets in terms of availability of capital. That was not true a decade ago.
With the recent SEC adoption of Title III of the Jobs Act, non-accredited investors can start investing in private companies. There are limitations and reporting requirements which will certainly limit the adoption of Title III fundraising, but even so, we have crossed a threshold here that should lead to more individuals investing in privately held businesses over time.
Privately held companies are increasingly using electronic stock ledgers (like the one our portfolio company eShares offers) which allow them to easily manage a large and rapidly changing cap table, much like the function that brokers and transfer agents provide in the public markets.
So, as you can see, we are slowly witnessing the blurring of the lines between the public and private markets.
But maybe the biggest “tell” is the recent brouhaha over Fidelity’s public markdowns on its holdings of well known startups. One of the many reasons companies don’t want to go public is they don’t want to have to deal with a valuation that moves around all the time without their ability to manage it. Well guess what? If you raise from certain investors in the late stage growth market, you are doing that, even if you didn’t realize it.
I don’t think we will see less of these public markdowns. I think we will see more of them. And we VCs are now facing the choice of whether to markdown our portfolios in reaction to Fidelity’s markdowns or explain to our investors and auditors why we did not do that. Since our quarterly holding values don’t really matter to us (cash on cash returns are what matters), it’s easier to markdown than discuss why we didn’t do that.
It’s interesting and noteworthy that when the private capital markets got the benefit of large pools of capital coming in, that came with increasing transparency. Of course it did. We just didn’t realize that was going to happen. Staying private won’t shield you from the pains of going public. Because the lines are blurring between the private and public markets and we are in for more blurring and it will come faster in the coming years. Be careful for what you wish for, you may just get it.
Would that not reflect efficient market theory extending from public to private as information from private becomes more symmetrical to investors representing the investing public?
Will this market shift increase pressure on venture firms to exit investments pre-IPO, as their investors are not getting the diversification from public markets which is part of their reason for investing?
If liquidity is also extended to the private markets, the difference between public and private is almost nil. If you are reporting like a public co.
Tis a chill wind blowing through the markets right now. Maybe you should have widened your article to include private benefits vs public benefits? Maybe the fundamentals of what tech and VCs do or don’t do for the rest of us, is worthy of further elaboration?
Fred, I think it’s likely that VC “best practice” will migrate towards an OPM method of valuation as opposed to marking positions to the last round price. This will be especially impactful on later-stage financings with complex preference stacks and kinked payout curves, as Series A, B and even C investors’ interests begin to diverge from those of Series D and E investors. Regardless, I believe this is a healthy evolution towards a more honest, risk-adjusted methodology than simply saying “Hey, I own x% of Company Y that just raised at a $2BN post and therefore my position is worth $z.” It’s only worth z if values continue to increase unabated. As we all know this is seldom the case over 10-15 year cycles.
“…explain to our investors and auditors why we did not do that.”Just tell’em you and your partners know a shit ton more about startups than brokerage firms and mutual funds.
Don’t know that is truehttp://avc.com/2015/07/mayb…
OK, good point, and extra credit for the source (yourself). I can think more highly of the USV team as compared to the Fidelity team. But you shouldn’t; that would be hubris.
the post on gambling was last week. this post is about hardened professionals.
StartupKings and PortfolioDuel were banned by the NY Attorney General????
One main difference is they perhaps may not be as biased towards their investment theories, and stick to more general value model. How they value a portfolio though may depend on if they are expecting a winner-takes-all market and if they invest in competing or even overlapping platforms and services. How long of a game they’re planning to play will factor in as well.
Agreed. My main point was that Fidelity isn’t necessarily more reliable a source on valuation than any of the other investors in a deal, angel, VC, or later stage money. Fidelity may be right, but not necessarily. And for USV to have to answer to their LPs and accountants as if G-d has reset a valuation is not right.
It’s interesting anyway – and the process may protect LPs from potential fraud by VC.
That is a real concern https://medium.com/@kubakos…
Those examples are a fantastic clusterfuck. That is “dumb” money being handed out. I suppose it will only maintain itself if enough people are making money, however better due diligence or simply not rushing to find and invest in the next “big thing” – before a product is even created – may be the solution.
Jim why give up that easy ?In business it’s not as if people don’t resort to hyperbole and/or stretching the truth to make a sale, right? Obviously you would have “fallen” for that line , right? No reason to think others might not as well. “good point” “Just tell’em you and your partners know a shit ton more about startups than brokerage firms and mutual funds”
Is this business? I thought it was commenting?
My retort: Well now. When you tell a joke here and it falls flat I am sure that you don’t think “sokay it’s not like I am in a comedy club”.The truth is (and I do believe this) the fact that you thought it was a reasonable thing to say actually means that it makes sense. Fred (edit: reply) is a good example of not being able to think down to the masses and what they believe.   I’ve made this mistake myself many times. Not fully understanding the stupidity of average people and what they will believe. Now a word about Trump: Trump understands this concept very well. The pundits, talking heads and the mainstream media apparently do not (except when slinging their own invented stupidity).
Trump… Godwin’s Law 2.0
My 2nd comment to your comment is that even if what you said was wrong in some way if you question what you are thinking and might say to much then you end up having brain stutters and say nothing at all.  And that is not good. Stifles creativity. Comedy (and business) as you know is about taking chances and going with your gut. Working in a corporation is worrying about everything you fucking say all the time for fear that it might make you look stupid or be a step in the direction of losing your job. Which is why it’s great to be an entrepreneur running your own show and not have to worry what anyone fucking thinks. It frees you to just cultivate outlandish thoughts and ideas that might actually work.
+1 Monday morning zinger!
R&D Tax Credits.
@disqus_OOX6QH1UpY:disqus ‘s top comment on that day is one of many reasons why my first boss had zero interest in going public.
Back in my public equity days I decried the silo-ization of knowledge in the typical brokerage firm. One of the things I wanted to see was the same “kernel” of information/knowledge (I know there is a distinction to many) get stored and repurposed across equity (public and private), fixed income, derivatives, capital raising, etc… with the appropriate safeguards in place. It would be more efficient and more generative. It never really caught hold. In hindsight, the one thing I wish I had done more as a public equity analyst was to talk more to the VCs about what was going on the private markets. I did towards the end, but only as I got more involved in banking. Past 15 years have been spent mostly on the private side, although I think with the looming dislocations of the edge access providers it might be worthwhile to go back into the public realm given the knowledge and insights I’ve gathered.
Then VCs will have to fund the cost of setting up disclosure processes similar to those we have to do for public companies for their portfolios–no?Is there any work being done to streamline disclosure? Painful and costly for public companies.
Is there any work being done to streamline disclosure? Painful and costly for public companies.Sounds (if true I am going on what you are saying) like a potential opportunity for someone, perhaps an additional service offering potentially from eshares.
there are a number of “cloud based data rooms” that private companies use when they do secondary transactions and tenders. i see them as the products that can take us where we need to go
Thanks.Have more experience with the public markets than with these private ones honestly. Good info.
If public and private markets truly converge, what would be the impact of IPO going away as a form of liquidity on VC? It seems that when VCs currently sell in secondary there is another VC or PE or Family Office buying. Those are still far and between.If IPO is gone that means that there maybe be a private equivalent that would allow long tail / public buy and get VCs liquid? It seems like it is the same thing as IPO?What is your take on that?
The gap will close until its non existent as the “app coin” model takes over. Ponder http://avc.com/2014/03/unre… in relation to this blog post and your question. i.e. there will be no liquidity event.
what’s the thinking with US publicly traded companies to have two types of shares, equity shares and voting shares? in the UK an equity shareholder votes and controls the company’s destiny, but in the US founders (in web tech at least) have control, which seems like a good thing.
maybe it is and maybe it isn’ti prefer one share, one votebut that’s because i’m an investor, not a founder
Great post, Fred. Let’s not forget the negative impact these markdowns have on employees joining these companies at an early stage. Employees are thrilled to get on board with a unicorn only to find that their options are suddenly underwater thanks to a big public markdown. Hopefully this trend causes entrepreneurs to pull back a bit on chasing unreasonably high valuations that eventually get corrected when equity becomes more liquid.
Good point on employees.
Fred I just moved my cap table etc to eShares. Brilliant product. Are they going to release an exchange that allows liquid trading of vested employee options at some point? I think that could be very interesting, allowing anyone to buy shares from employees on the platform, and facilitating liquidity with minimal management from the founders / lawyers.
I love eShares. Persuading as many portfolio companies as I can to use them.
well i can’t say what their roadmap is, but i will say that they have a “long one”http://avc.com/2011/11/long…
I think there is a big long term network effects play here that could see them coming a stock exchange of sorts.
On the Square IPO and deals from the last private round.http://www.cnbc.com/2015/11…
The problem with the JOBS Act and the rise in crowdfunding is that they don’t address the true problem with the market…it is easy to get into an investment…but how do you get out? Access is far less valuable than liquidity…
a liquid secondary market for private companies is the logical place this is all going
i dont disagree. and sorry to be thick. but isn’t a “liquid secondary market for private companies” the same thing as a public market?
Not necessarily. If we deregulate the front end of the funnel and not the back end, we are creating a clear and foreseeable problem. Today’s public markets are heavily regulated and access is restricted to both the cokpanies and the parties that might wish to transact. I believe that market forces will push the community to remove this friction…and this solution will become one of the biggest growth opportunities in any market.
I agree. We are thinking of starting a fund to focus on entrepreneurs and companies that are driven to create solutions to the illiquidity of the growth cokpanies that will not reach the public markets.
With the question being, how will it be regulated?
From what I remember, Xpertfinancial was making the push, at what now looks like the perfect time, but never made it.
Looked at this http://pointsandfigures.com… here. I think Albert is correct-the more information the better the valuation. This is Eugene Fama’s efficient market hypothesis in action. The problem with VC is that you only get a chance to value a company every 12-18 months. The public market can value it every second. Additionally, in VC financing you aren’t just pricing in past growth, but expected future growth. As we know too well, it’s pretty hard to calculate expected future growth exactly. With the other pressures (easy 0% money, more money coming in to later stage), the speculative pressures have driven the price higher. Agree with you that it’s going to change.
Good article. Hopefully, then the marked-to-market action filters down the food chain to seed and Series A. You still have the problem not only of the funny money in the public markets (FB’s, GOOG’s valuation) that drives the private valuations, but also the craziness around what FB or GOOG want to buy. Cause they have the currency VC’s believe in. That cluster-f–k mentality doesn’t get marked-to-market as quickly. We saw that in the 1990s with MSFT, CSCO, AMZN et al.
Question about that post. Don’t private markets and private investors have access to a great deal more info than many participants in public markets have? Hence are in a better position to assign value (assuming they are smart enough to do that of course). If you are an angel or VC and considering an investment in “XYZ” you can ask many and any question, get answers, and even get future direction or company strategies that in many cases would never be publicly disclosed, correct?   You can easily clarify concerns that a public investor would never be able to do (with the exceptions of the largest and most prominent perhaps) Which is why some of the investments that a VC makes (even Fred) that we read about here often seem foolish or don’t make sense. We only know what we are allowed to know. The investor is privy to a pool of details that can guide them in their investment decisions. Even reading the tea leaves I would imagine. I have a company that I am helping that is telling me to “hold off” on something they were quite interested in a half year ago. From various other information I know about I am guessing that they are potentially going to be acquired because it’s the most likely reason they don’t want what they previously had wanted. Even the phrasing of email replies points to that. Not with absolute certainty but with enough to make a bet on.
Most VCs argue that their best investments were contrarian to the VC pack.
Another example of this convergence is in more private start-up companies sharing core financial metrics publicly e.g. Kickstarter, Buffer etc. You could argue that Kickstarter or Buffer’s stats page is more publicly transparent than quarterly earnings calls.
great point. etsy also did that before they went public.
Corollary is Crowd Funding Campaigns where the donors *DEMAND* greater transparency from the campaign owners of what their money buys them, where the product is and when they’ll get delivery.
https://baremetrics.com/open most are bootstrapped
The value of diversity in opinion is really important.If USV were to do the “easy markdown” it would imply that their thoughts regarding the whole were lead by those on the margin (ie the first to “break ranks”)- if so, arguably they have an even bigger difficulty to explain why they needed someone to go first !I would hope (and I expect) your investors value your unfettered opinions – otherwise they would be better off investing elsewhere (or ???)PS respect for putting this out in public !
To me the biggest takeaway: When Albert has a well-thought through theme, he’s almost generally correct, even if it takes years to come to fuition
we are so lucky to have him as a partner
This is a good point. A couple times in the past I have been thinking “wow, that’s ‘out there'”. And yet…
Is Fidelity as clueless as a lot of folks are making them out to be? A few days after the report of the markdowns, WSJ ran the piece about Zenefits (whose value was cut 48%) running into revenue problems and cutting costs. And though they’re still experimenting with formats, maybe Snapchat is running into issues meeting revenue goals shared with Fidelity during the raise?And will the line continue to blur between public and private or will private companies just get more selective about who they take late-stage money from?
here’s what i have to say about “fidelity is clueless”http://avc.com/2015/07/mayb…that’s from July but it is highly relevant to this discussion
“listen auditors – I know Fidelity and their hundreds of analysts are slicing valuation…they’re just doing that to build up the honey jar for when they need a boost down the line…remember what GE used to do in order to miraculously meet earnings every quarter? Uber is clearly worth $100 Billion; if it just had 1% of every logistics market in the world , Ok wait look at the CEO’s track record, Ok wait look at our Possibility Case, if…”
How is employee liquidity for these high flying private companies? It strikes me (anectodally) that it’s not there.
Regardless of availability of capital, liquidity is an important differentiator between public and private. Yes, companies can benefit from the distraction of the “random walk” of stock prices by staying private. But, lack of a liquid market creates difficultly in valuing any security. If/when secondary transactions take place, most transactions are at the recent post-money or 409a (for common) as opposed to what could be a more up to date market price. The lines may become more “blurred,” (and certainly for raising capital the markets have converged), but not until there is adequate liquidity in private markets will public/private markets really be all that similar.
Hey Fred – no question that the lines are blurring. Not sure I am on board with VCs markdown (or ups) based on what the late stage guys assess as the mark-to-market. It’s not really a “market price” but more of a formulaic approach that Fidelity, Blackrock and others determine. Not sure these formulaic approaches are a good substitute to an actual market event. But, not doubt these markups/markdowns will be more frequent and will represent some indicator of momentum.
A future post that expands on instances of having had to mark down a portfolio would be welcome IMO.”Brouhaha”? Is French culture rubbing off a little? He he…
IMO public company communications will look much like Kickstarter does today in about 10-15 years. Transparent and much more genuine. Twitter and others are moving in this direction. Private companies that seek outside financing will also move this direction. The lines should blur in most regards.
Although cash return is what matters most, if the public-markdown-of-private trend continues, is there a possibility of it influencing an LP’s response to fund creation by an affected VC? I.e. LP X decides that Fidelity’s markdown of some of VC’s portfolio companies (especially if they represented the highest probability for blockbuster exits) indicates reduced likelihood of high returns, therefore, LP chooses not to invest in next fund due to reduced confidence in that VC.
I think the markdowns are problematic for two reasons 1) pointed out below is impact on employees and options and 2) VCs in the first or second fund use paper returns to “show” performance when they may have little to no cash-on-cash to show.
Great post. Fred – do you expect VC portfolio markdowns to correlate closely to those by Fidelity or other similar investors for the same portfolio companies? What has been the historic norm? It will be interesting to track the late stage funding and valuation environment over the next several quarters.
Were these markdowns below the 409A valuations being used to price employee option strike prices? How different are those valuations compared to a “unicorn” valuation?Uber is raising money at $60B but what’s their 409A valuation?
It’s very likely that the values from Fidelity et al are not comparable to 409A valuations. I believe that the former are generally investments in structured securities (convertible preferred with a liquidation preference, possibly a ratchet, etc.) while the latter are issuances of straight common options or restricted stock.
I guess I am missing something big here, but I don’t get the Fidelity markdown gig. As Square S-1 unvelis, those late stage investments are more debt than equity. Downside protection, interest and ratchet should make their holding indifferent to lower valuation anyway. So why marking it down?
They do it because … they have to. Also the requirement to reset valuations applies just as much to marking up an appreciated asset as marking down a depreciating one.The key point is that investors can buy and sell shares in a mutual fund on a daily basis – and they do so at NAV (Net Asset Value), the price reported by the fund. Hence, as “open ended” investment vehicles, mutual funds need to mark their valuations to market on a daily basis to reset that NAV.With public securities assessing the contribution to NAV is “easy” in most cases. For illiquid securities the valuation reflected in overall NAV needs to be “fair value as determined in good faith by the Board of Directors”. (BoD of the mutual fund that is.) Hence to the point of this post, by taking mutual fund investments a private company goes (a little bit) public by proxy … because the valuation of its equity is open to potentially daily reassessment by a mutual fund. However, unlike the public markets, any revaluation (again up as well as down) is only visible when a fund choses to make it public.Fidelity funds report monthly holdings although the SEC requirement is for mutual funds to report holdings to them (and hence the public) only on a quarterly basis. Even then funds have up to 60 days after the end of a quarter to do it. And just to make it clear that this reporting needs to be honest and fair … the SEC requires a fund’s principal executive and finance officer to “certify” the holdings report is accurate.
Secondary Markets is another great alternative for them however, availability of Capital in Private do increase the pressure on the Company to Exit from Investors… Ain’t it True ?
Everything blurs. This may be an over-general point of view, but I see this as cyclical: current understanding starts as a simple take on a confusing mess, and gradually gets more and more complex/nuanced – until it becomes another confusing mess, and you have to start again with a (possibly different) simple take on it. The Circle of Understanding, as it were.
Times are changing, that’s for sure. Great post and just to add, Fortune did a nice job reporting on the the recent number of write-downs.http://fortune.com/2015/11/…Some interesting new twists on how Fidelity is valuing the fund with greater independence.
It seems to me like the headline valuation numbers mayoverstate valuations, and as companies stay private longer these valuationestimates will become more and more inflated. By that I mean: late-stage valuationsseem to extrapolate the price paid for the latest round of pref shares to therest of the equity cap structure. So as companies raise more private capital(and especially if the economic terms of later rounds get increasingly preferential),there is a greater disconnect between the value shares at the top of thewaterfall versus the value of shares at the bottom. The longer a company staysprivate, or the more rounds of private capital it raises, the less it will makesense to use the latest fundraising round to value the entire share base. Inthat sense “public markdowns” against implied late-stage valuations should beexpected. Am I thinking about this correctly?
It gets blurred even more with people like me moving from the US equity capital markets to the private side. Check out http://alphavisor.com to find the best private companies.
Albert Wegner (@albertwenger) is a genius. This is exactly right “we should have one market where the more a company discloses, the more liquid their security becomes”. This is exactly what we’re solving for by combining some heavy data lifting and some serious cognitive incentives to get companies to disclose in exchange for much faster and much more efficient fundraising experiences.
Why would anyone drive from NYC to LA and not stop in Chicago?Oh right, because they have no idea what good pizza tastes like.Sorry, just thinking aloud.