Private growth companies stay private longer, and it makes sense for stock exchanges like Nasdaq to help these fast-growers earlier, before they even start thinking about an IPO. In 2014 Nasdaq Private Market launched, now it’s coming to Europe and we were interested to learn more.
In March 2014 Nasdaq, the stock exchange operator, entered the pre-IPO market with Nasdaq Private Market “The market for private growth companies”, then a joint-venture with San Francisco based SharePost. In October 2015, Nasdaq bought out SharePost from the venture and is now in sole control of Nasdaq Private Market. Nasdaq has since also acquired SecondMarket, a provider of a software platform for trading private shares and other instruments.
Now Nasdaq Private Market is launching in Europe and we wanted to learn more and sat down with Adam Kostyál, Vice President at Nasdaq Nordic and responsible for Nasdaq Private Market in the region.
“With a private market, the step to an IPO will be much shorter, if the company ever decided to go public”, says Adam Kostyál, adding “Investors can access startups before they go public, startups can access capital before they are ready to IPO, while early investors, founders and staff can gain liquidity, for example sell employee stock options before an IPO to pay down a mortgage.”
Ok, so what’s the product? Nasdaq Private Market offers private companies three main features. A company that is just interested in better visibility and credibility can become a Member of Nasdaq Private Market if it meets certain criteria. Nasdaq also offers an electronic share register called ExactEquity that allows companies to better manage their cap tables for all instruments like stocks, options and convertibles. The service is freemium and looks quite useful as many growing companies faces complex cap tables with an expanding number of staff shareholders and investors. It could provide an alternative to what many companies use today, i.e. an outdated excel sheet. And as the main offering, Nasdaq offers liquidity events, allowing staff and investors to trade shares and options on a transaction platform, without being a regulated stock exchange, enabling private companies to both raise new capital and manage secondary transactions. On top of this Nasdaq can also offer its members online marketing, social networks and even the big screen on Times Square in New York City for the company that wants to boost its image.
In the US, Nasdaq Private Market has structured a secondary platform for one of the most well-known internet brands, a company with over 500 staff, based in San Francisco and that has so far raised over $1.3 billion with a valuation expected to be around $10 billion. The main reason for the trading platform was to create liquidity (i.e. money) for employees and allowing them to sell options and shares. This is becoming increasingly important to attract and keep key personnel. Nasdaq believes it makes sense to set up a transaction platform for companies with at least 100 employee stock or option owners.
The workings of Nasdaq’s trading platform is quite straightforward. The company knows both the sellers and the buyers that are identified beforehand. An advisor like a corporate finance or accounting firm suggests a fair market price, and the company decides when to sanction the share transactions, and the volume of shares to be traded. It is only the company itself and the buyers and sellers involved that have information about the transactions. There are no public price listings like on a regular stock exchange. Also the internal information is restricted to the parties involved in the transaction. If an employee sold her options, the colleagues will not automatically know about the transaction or the price. The situation is very controlled. The company also sets the periods for these transactions, for example quarterly or half year. The bottom line is that private companies can retain some control of their shares, and the composition of their ownership.
So what is the cost for the company and should entrepreneurs spend time on this? According to Adam Kostyál there is an initial investment, but the upside is that these, perhaps unavoidable, transactions can then be made more cost-efficiently and better in the long term. The actual cost is a fixed price with a variable price based on the number of participants in the company-specific market place. The electronic share register, ExactEquity, is freemium for companies with up to 30 employees.
Can any company become a member of a private market? In general, companies that would like to use Nasdaq’s private market must have raised at least $30 million in funding in the past two years or have a valuation north of $50 million. These companies also need to be profitable, with at least $750,000 in annual net income. In Europe, the demands are somewhat lower, Adam Kostyál adds, and instead of the $30 million in funding, a sizeable A-round is sufficient.
In the US, companies like Airbnb, Uber, GoPro and Pinterest have decided to stay private for the time being, while still offering staff and early investors liquidity (i.e. the opportunity to sell shares and options). Between 2010 and 2012 there was intense secondary trading before the IPOs of Facebook, Linkedin and Twitter, prompting many companies to adopt strict no-transfer clauses to avoid chaotic trading. One of the main reasons for the private secondary market today is company-sponsored tender offers, where the company makes it possible for staff and early investors to sell options and shares to select buyers.
Which companies are we likely to see appearing on private markets in Europe? It seems Nasdaq is targeting well-known companies that have reached a valuation of $1 billion.
“To establish Nasdaq Private Market in Europe we are primarily going after Unicorns”, says Adam Kostyál. Why? “They have the brands that can help Nasdaq launch private markets, they have complex needs we can solve and they might also be closer to an IPO. There is a challenge to be pre-IPO ready for these companies, even though they are not planning to go public at the moment.”
So, is this just a way for Nasdaq to secure more IPO-business from the largest and most promising private companies? “No, private markets should work on their own merits in a private equity ecosystem, since the trend is that these companies stay private longer, and hence the need. In the meantime they have to handle liquidity for employees and investors, and longer term as they grow they might need a public environment”, says Adam Kostyál, and adds: “The big banks and their private banking divisions have not really seen the potential in this, I think. In a large unlisted company that starts liquidity programs on private markets, there might be hundreds of potential millionaires who would be attractive targets for financial services.”
However, Nasdaq, too, might be a bit late to the market. Adam Kostyál is worried that Nasdaq did not develop important relations with large private companies while they were smaller. But it’s not self-evident to just bring a US concept to Europe without challenges. There are significant differences between the two continents.
In the US there is a common frameworks for employee options, making it easier to start liquidity programs on private markets. In the EU there is no such harmonised system, and the tax rules differ much among the various European countries. While shares are more standardised, there is not the same opportunity to roll out option programs on private markets in Europe. In other words, there is neither the sufficient conditions nor critical mass for liquidity programs in the EU, and thereby not the immediate need seen in the US.
This isn’t Nasdaq’s first attempt at running a secondary market for private companies. Nasdaq launched BX Venture Market in 2011 as a marketplace for startups, and in 2007, they launched the Portal Market as a regulation-free marketplace for unlisted equity securities. These efforts were not great successes.
Why might this work now? What is the trend?
First, there are far more private companies today with valuations above $1 billion that will attract both institutional investors and analysts. In the years since the financial crisis in 2008, we have seen a tremendous growth in the technology sector with investments increasing across all stages, both in the number of rounds, the total capital volume invested and the size of the average financing round, especially in the US.
Secondly, the fast rise of the tech sector, or call it comeback, paired with the emergence of spectacular new tech companies and improving VC returns have attracted global private capital such as traditional private equity and VC investors, pension funds, mutual funds, family offices, asset managers, investment banks and other institutions. With historic-low and even negative interest rates, traditional public market investors are seeking returns in alternative assets, i.e. assets outside the stock exchange and bonds, resulting in a new and increasing pool of capital being invested in private growth companies that can in turn stay private longer, with no immediate need for an IPO to access public capital to fuel continued growth.
Thirdly, the legal frameworks are also changing, particularly in the US. Secondary markets are more viable now that the JOBS act (passed in 2012) allows companies to have 2,000 shareholders before they need to disclose their financials. Before, a company was practically forced to go public when they reached 500 owners. Adam Kostyál adds that there is also an increasing understanding among institutional investors in the market for the fast-growing company that invests significant capital in growth, while showing no immediate profits. A company like that would have a hard time on a public stock exchange.
At some point many of these major private companies may choose to IPO anyway, when the number of their shareholders grow or they need to access public capital which is still a much larger pool than private funds. This transition has proved to be tricky, since valuations in the private market tend to differ, sometimes quite substantially, from the public domain.
The day after Square’s IPO, Bloomberg noted: “Square’s day-one surge underscores the challenge of pricing shares in startups that, while private, attracted lofty valuations they may not be able to sustain once they’ve gone public and become subject to broader regulatory scrutiny.” As is well-known, Square had to lower its share price in the IPO, compared to the last private round. The market value of unlisted companies versus their public market value as listed can sometimes act as an incentive to stay unlisted longer, with the obvious risk that private markets will continue to drive up valuations.
In a recent article (“The rise and fall of the unicorns”), The Economist explores how institutions mark-down the value of companies like Dropbox, Snapchat and Zenefits by 20-50% presumably for not meeting expected growth targets. As a result, it might become harder to access the private capital market for financing large later stage rounds, and these companies may then have to turn to public markets with demands on real revenue and profits.
So, we ask – are private markets sustainable? “There is of course a correlation between public and private markets, a slowdown or a recession will also affect the private markets. Private markets also fulfil new and long term needs for private companies. And in the near future private markets will not only be for unicorns, but for any growing private company”, says Adam Kostyál.
There is still a big difference between a private market and public market listing, regarding for example reporting, transparency, disclosing financial information and investor universe. But private markets may offer a “third” exit route besides an IPO and a trade-sale, if investors are willing to accept the higher risks. Private markets, especially under Nasdaq’s trustworthy brand, lends a level of credibility, while they are not regulated and controlled like a public stock exchange.
Can you view a secondary private market as an “IPO School”, a transitional stage where entrepreneurs can learn about the public life, before taking the full step?
“Yes, it’s a way for entrepreneurs in our network to share knowledge with each other about running their companies in a more professional way and what’s it’s like to be more public”, concludes Adam Kostyál.