Putting Private Markets First

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(This is the unabridged version of Alex Lazovsky’s recent post on Forbes.)

Many signs point to greater convergence between public and private markets, and venture capital has good reason to feel deeply ambivalent about their increasing similarity. To understand what this convergence might mean for venture capital and private equity, let’s take a look at the differences between public and private markets, what changes are on the horizon, and what they imply for funds and investors.

Different Leagues for Different Players

Public markets are probably the most familiar, the brand names: NYSE, Nasdaq, LSE, etc. They are easily accessible, highly liquid, and pretty boring, especially in the last decade. Generally, short, infrequent periods of volatility punctuate longer stretches of modest, predictable growth. The public markets are tightly regulated, and information about public companies is plentiful. Retail investors looking for a “set it and forget it” strategy as well as institutional investors looking to balance predictability and yield are likely to feel at home on the public markets.

Private markets are less predictable and less formal. While there are exchanges for privately held equity, like Forge Global, a lot of business is conducted across conference tables. Private markets are home to companies ranging from garage startups to hectacorns like SpaceX and Stripe. Their volatility is hard to quantify because information is much scarcer, and it’s hard to track all the startups that fail to survive even their first year.

Always good advice (image: janilson furtado)

What is clear, though, is that private markets can punish set-and-forget strategies harshly. They are more suited to “investigate and cultivate,” i.e. investors and managers willing to devote considerable time to researching the best deals and monitoring them assiduously.

Signs of Convergence

There are several indications that private and public markets are becoming more similar. The first is the existence of secondary market exchanges, where employees, founders, and early stage VCs can turn their equity into cash before an official exit. Platforms like AngelList give retail investors access even to early and mid-stage startups. Thanks to such markets, private equity can be bought and sold without any direct interaction between the buyer and seller — just like the public exchanges.

Another indicator is the “maturity” of companies when they go public. Back in 1999, the median age of companies going public was five years. It is now 11. In the same period, their median valuation at IPO has risen by over 6x. In other words, companies now wait longer and grow bigger before going public, so when they exit they look more like the established public companies of the previous generation.

Third, regulators are not oblivious to these changes, and they’re also treating private markets more like public ones. For example, the SEC is looking to increase reporting requirements for unicorns. While few rejoice at the prospect of new regulation, it makes a certain amount of sense when you hear things like “Retail [investment] has been the holy grail of private markets since … a generation ago.”

Perhaps the most decisive indicator are expectations in the industry. Prophecies in this business have a tendency to fulfill themselves. So when strategies adjust to account for the convergence, and experienced VC managers say “I’m going to be more conservative until we see more of an alignment between private and public equity,” the alignment everyone anticipates is just a matter of time.

Implications for VC

At first glance, convergence between public and private markets might seem thoroughly positive for venture capital. After all, public markets are where many great exits happen; they’re the terminal point of our efforts, our goal. If public markets are good, and private markets are starting to resemble them, that has to be good too, right?

On further thought, we might start to miss our less formal private markets when they’re gone for several reasons. First, what would ‘exit’ mean without distinct private markets? Exits are when venture capital and private equity divest and sell our stakes to retail, institutional, and corporate investors. But if retail investors were to start participating even in early and mid-stage funding rounds, would that count as an exit? If not, what would? If Forge Global starts to look more like the Nasdaq, and Angellist starts to look more like Forge Global, where would we find the threshold between public and private?

Exits must be clear to be useful (Image: Rayson Tan)

The second reason to dread convergence is the loss of agility. Startups need to learn how to be what they’re destined to become. Such learning involves many mistakes and furious innovation. By contrast, retail and institutional investors reward public companies for caution and predictability. This is exactly what Mark Zuckerberg meant when he changed the Facebook motto from “Move fast and break things” to “Move fast with stable infrastructure” (~yawn~). Throttling the pace of startup growth and change not only restricts the range of innovations benefitting society and the speed of their development; it changes the game entirely. Instead of underappreciated geniuses developing disruptive technologies, we should expect sure-things managed conservatively by risk-averse bean counters.

Private markets also have a proven niche. They’re full of activity because there’s demand for investment opportunities between highly regulated public markets and casinos, markets where connections and acumen matter. It’s entirely appropriate for regulators to protect casual investors and systemically relevant assets like pension funds. But without vibrant private markets with commensurate regulations, sophisticated, experienced, risk-amenable investors will seek other less regulated and potentially less socially beneficial avenues.

Where else would the $130 billion of venture capital invested in US firms go otherwise? DeFi? Formality and regulation creeping into existing private markets could push resources into far less formal and largely unregulated opportunities. Promising startups would get lost in the wilderness, due diligence would be a thing of the past, and mainstream investors would be pushed into the unsavory margins.

It’s important to remember that private secondary markets are not defective public markets. They are not less than public markets, merely different from. They need (and have) different rules for different kinds of actors because they serve different purposes. Only separate entities — like public and private markets — can work together.

Just like public and private markets, rowers on each side of the boat need each other. (Image: Josh Calabrese)