A Stock Exchange For Private Companies

Is there anything more depressing than your side project’s domain name coming up for renewal? It’s then you realize – for yet another year – that all you’ve really accomplished was buying a $12 domain from GoDaddy. We’ve all been there. For most people, that will be the extent of their foray into entrepreneurship. Those who do put up a website will realize that while having a CEO bio on an “About Us” page is pretty cool, they still have nothing. So, they’ll “try to raise money” and start asking venture capital firms to sign NDAs and never make it into a meeting.

People who get meetings have something that wantrepreneurs don’t – traction. Nothing shows traction more than eating your own dog food, that is, using your product in the manner in which it was meant to be used, realizing the benefits, and then saying “see, you can do this too.” A few weeks ago, a company called Carta did something very cool. They sold shares of their own company on their own exchange. To understand the value proposition, let’s start at the beginning.

Startups vs. Publicly Traded Companies

Some of our readers ask why we bother to cover startups when most retail investors can’t invest in them. The answer is that we need to be aware of what opportunities are coming – Twist Bioscience is a good example – or what threats might exist for stocks we’re already holding. Grail and Illumina is a good example of a story that played out between a public and private company. All of the stocks we hold (we eat our own dog food too) face threats from startups looking to emulate their successes.

One of the most frequent questions we get is how to invest in startups as a retail investor. If you are an accredited investor (which means you have achieved a certain net worth most people haven’t), you can go to “secondary markets” such as EquityZen or Forge and buy shares in startups from sellers. Usually, these will be existing investors in the company or employees looking to sell shares for whatever reason. There are a few problems with this approach for retail investors, aside from the need to be accredited.

The Need for Liquidity

The first problem is that minimums are quite high for people who like diversity. For example, let’s say you wanted to invest 8% of your wealth across 10 startups. Since the minimum you can invest in any startup is $25,000, that means you need to have a $3.25 million dollar portfolio to accomplish that. Most accredited investors are probably playing with a lot less than that. The need to sell such big blocks is because there’s not enough liquidity in these secondary markets.

The Need for Information

The most concerning problem is the inability to understand what you’re getting yourself into. If you sign up to one of those platforms and start browsing the collateral for an offering, it starts to become very complicated, very quickly. Even if you wasted invested six-figures in an MBA, you’d still need a lot of time to digest all this information in order to make an informed investment decision. So, a fintech platform that can increase liquidity while providing accurate and standardized information about the assets being traded would be very valuable to investors.

Carta conveys their value proposition in a single sentence – “the first vertically integrated market ecosystem for private equity.” To understand that sentence, we need to start with the foundation Carta built which lets them “vertically integrate.”

About Carta

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Founded in 2012, San Francisco startup Carta has raised nearly $628 million in funding from names like Andreessen Horowitz, DFJ, Alumni Ventures Group, and dozens of other notable names in the venture capital (VC) world. All these VCs were probably the source of Carta’s first customers as they could easily guide startups towards Carta’s software offering.

Carta happens to be the leader in cap table management software used by 17,000 private companies. Simply put, a capitalization table – or cap table – is a list of all the securities your company has issued and who owns them. It’s something that founders and lawyers pay very close attention to. This information can be aggregated to answer basic questions like “who are my biggest investors?” or “how much money have I raised?” or “am I being compliant?”

An example of a cap table – Credit: Carta

If you Google “cap table,” you’ll find Carta telling you what a cap table is, offering you a free Excel cap table template, and then convincing you not to use it. Most companies that put their cap table in Excel usually end up with some convoluted mess that an attorney will happily charge $750 an hour to translate into something worthy.

Carta makes it easy for new companies to find them and use them. The Carta Launch plan is available through law firms and gives companies with up to 25 stakeholders that have raised up to $1 million access to cap table management for free. Carta is a great example of a company where their data is turning out to be more valuable than their core product offering. What they’re now able to do is create a stock exchange on top of that foundation allowing institutional investors to invest in private companies with financial data that comes from the horse’s mouth.

About CartaX

Finally, a private stock exchange,” was the title of a Medium piece a few weeks ago talking about how Carta successfully sold their own shares on their own platform. Below you can see the progression of their market cap over time as they followed the yellow brick road of funding rounds to their first day of trading.

Credit: Carta

The first day of trading saw 1,484 executed orders coming from 414 participants. Nearly $100 million in shares traded hands at quite the premium to the last funding round’s price ($6.9 billion today vs. $3.1 billion as of May 2020). Demonstrating that the platform works is a step towards having an exchange that can replace both the special purpose acquisition company (SPAC) and the secondary market.

CartaX vs. SPACs vs. Secondary Markets

We’ve talked before about how SPACs do a disservice to retail investors for any number of reasons. Some of what’s happening make the late 1990s stock price action look about as exciting as watching T-bills mature. The recent rumors of a Lucid Motors merger with a SPAC called Churchill Capital IV (CCIV) have shares up over +520% on the rumor alone. With 40% of SPAC trades being made by retail investors, hedge funds are laughing all the way to the bank. Any well-meaning retiree who decides to invest in any of these SPACs is quickly going to get steamrolled as the Robinhood weekday warriors turn the market into one big casino.

From the perspective of a startup founder, SPACs seem like a no-brainer. Make hay while the sun shines. After the SPAC issuers who make millions for very little actual work, it’s the founder who is next in line to benefit with a giant pile of cash they can now use to extend their runway. The goal of every business is to survive, and they just increased their lifespan by a few years with very little work.

It’s the retail investor who actually wants to invest in Lucid Motors right now who is getting the short end of the stick. That’s where CartaX can provide the same benefits as a SPAC without all the cow manure. The venerable WSJ published an opinion piece last week which talked about how “private-share markets including CartaX and Nasdaq Private Market offer startup shareholders seeking liquidity an alternative to IPOs and SPACs.” This is a good segue into talking about competing platforms where investors can transact in shares of private companies, what we refer to as “secondary markets.”

The OG of secondary markets was the aptly named SecondaryMarket which was acquired by Nasdaq in 2015 and is now called the Nasdaq Private Market. The last time we looked at the remaining secondary markets in 2018 it was a three-horse race: EquityZen, SharesPost, and Equidate. Since then, SharesPost and Equidate merged and rebranded to Forge. Where Carta differentiates their offering from all these competitors is in the foundational cap table management solution that’s now being used by over 17,000 private companies. That’s a pretty formidable barrier to entry.

What Carta Thinks

The only good thing about Medium is that a fair number of company leaders use the platform as a mechanism to communicate with the masses. Unfortunately, they’re using Medium, so their messages usually get lost among insightful gems like “The Little Mermaid Is Really About Unrequited Gay Love,” or “Is Penis Size Genetic?” (the answer is kind of, sort of). Fortunately, that didn’t stop Carta Co-Founder and CEO Henry Ward from dropping some wisdom about his company on Medium.

Mr. Ward says it’s odd that private markets have zero liquidity, public markets have hyper-liquidity, and there is nothing in between. This causes three main problems:

  • Employees live poorer because a large portion of their wealth is locked up in shares with no market.
  • Seed investments are more expensive for founders because of the excessive duration risk the investor is taking, not to mention how likely it is that most startups fail – increased total loss risk.
  • Late-stage startups have to compete with large corporations for talent without offering all the upside that comes with a startup. Most people would rather work at Microsoft than a late-stage startup. Mediocre talent would happily take either job.

That’s the case for founders to consider offering liquidity earlier. For their own shares, Carta plans to offer a trading window once per quarter which means their employees only sold a modest amount of shares in their initial offering as a few weeks ago. They know they always have the option to sell shares later.

If you’re a startup looking to offer shares on the CartaX platform, the latest Medium post says they’re booked through March 2021. That’s great to see. If you’re a retail investor, you’ll need to wait too. Right now CartaX is looking to onboard institutional investors. Funds like Draper Esprit or Scottish Mortgage would probably find the CartaX platform incredibly useful to manage their private company investments. It would only make sense down the road that a winning private equity exchange would start to accommodate accredited retail investors as well, presumably with low minimums because they have the liquidity.

A key value proposition of CartaX for retail investors is the ability to invest alongside institutional investors, not in the absence of them, as is the case for equity crowdfunding, something that investors should avoid like the plague. Loads of platforms let you buy shares in private companies that aren’t traded and are more or less worthless until there’s an exit event.

Conclusion

Our perspective is to always prioritize the needs of institutional and retail investors first because they pay our bills. We are adamantly against SPACs because they do a large disservice to anyone who wants to invest in the underlying target that’s being acquired by the SPAC. The people at the wheel of the SPAC vehicle want to get their 20% locked down before the music stops, so transactions are becoming more haphazard. If CartaX promises to displace SPACs, we’re all for it.

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