Traditionally people have invested in companies through IPO listing or stock exchange. Buying shares in a company can be done, not necessarily through the stock exchange or being a founder or establishment of a company but can be done through a secondary market for unlisted companies. Over the years, the private equity space evolved where the focus shifted from investments in listed companies to established companies looking for growth capital. Then came the Silicon Valley boom, which paved the path of completely different opportunities; investments in venture capital, green field, brown field opportunities and angel investors. With the current global economic uncertainties, technology advancement and evolution of the startup ecosystem, investors have realised that the real growth opportunities come from investing in private or unlisted companies. But then the questions are, how do they invest in such opportunities? How can they participate and capture the growth tide?
Or if you look from another perspective, many employees, investors or founders who have been lucky to have ownership in a startup, have seen an increase in investment value – but face limited liquidity options to optimise the value of their investment. Sometimes, they feel their investment size is too small to approach prospects interested to buy these shares such as secondary funds, HNIs, Family Offices etc. For such investors, the option for liquidation was mainly IPO listing.
Trends are changing and opportunities for such investors to liquidate are easy now…it is through offering their shares via the secondary market. Still many people are not aware about the concept of primary market and secondary market. Well, new stocks or bonds of a Company are sold to the investors through the primary market, while shares of a Company sold by an existing shareholder to a third party are through the secondary market. You may realise that the term “Secondary” is similar to the actual meaning of the word “coming after, resulting from someone or something else”. The stock market trading is a secondary market where one buys shares from an existing shareholder, except IPO listing, rights issue etc. You can also buy shares of an unlisted or private company from an existing shareholder through the secondary market.
In both cases, primary and secondary, investors are buying stock. The main differences being 1) where the proceeds go (if to the company, then it’s typically a primary sale; if to existing shareholders then it’s a secondary), and 2) whether the shares are newly issued (it’s a primary sale) or have belonged to someone else (in which case it’s a secondary sale).
Problem related to the market – liquidity is an issue
Shareholders of a listed entity can easily monetise their shares through the stock exchange whereas liquidation of shares for an existing shareholder of a private or unlisted entity is limited. The secondary market for unlisted companies is still nascent and unorganised.
Typically, the secondary market for unlisted companies was accessible to private equity and venture capital funds or asset managers along with co-investors who acquire a minority or significant minority stake in such companies. The HNIs, Family Offices etc. used to invest in the unlisted companies through these private equity/vc funds. The investment bankers/advisors/brokers were the intermediaries assisting in such transactions. Not only was such a transaction time consuming and lengthy but used to turn out quite expensive as well.
One of the main reasons why secondaries have become popular is due to the evolution of startup ecosystems. When the startup is doing well, investors want to get shares of the company, but the startup may not need the financing nor feel the need to dilute its existing shareholders by issuing more shares. The other reason is that early shareholders are looking for liquidity and diversifying their investment portfolio. It’s quite possible that a successful startup may not have an IPO for 5-7 years. These early shareholders or employees would be looking to partly encash their shares. But due to the current dynamics already discussed, it can be difficult for them to liquidate their shareholding.
The startup ecosystem clubbed with marketing and media exposure has created a wave of great demand for smaller ticket secondary transactions where HNIs, Family Offices, SMSFs etc. are looking at investing about $20k-$50K in shares through the secondary market. But still there are very limited platforms available which offer the secondary market services to acquire small ticket shares, which leaves us to the question of how do you access this secondary market?
Apart from the liquidity issue, private companies’ shareholders are also bound by the Shareholders Agreement which restricts a shareholder from selling their shares. There are a few important considerations if you are going to be involved in the secondary sale of shares in a startup. Each of these can complicate a secondary sale. You should be aware of these items before getting into a secondary sale:
- Right of First Refusal
- Right of Co-sale
- Pre-emptive Rights
- Waterfall Sale
- Restriction of SharesNumber of shareholders
Solution: liquidity to unlisted entity is provided through this
As mentioned earlier, when it comes to investing in shares, most investors think of ASX. But there is a lesser known but much more thriving share market which offers quality investments at good prices, the unlisted share market through secondary sale(s?).
To date most investors automatically associate buying and selling of shares with Stock Exchange. But while most shares in public companies are traded on the stock exchange, there is a booming opportunity in unlisted shares which are traded over the counter by investment bankers, investment platforms, specialist brokers etc.
Nowadays, many investment platforms, specialist brokers, and advisors are facilitating secondary sales. Though at a nascent stage, the secondary share market for unlisted shares is gradually expanding with more investors becoming aware about the potential upside to investing in companies at an early stage.
Today, there are limited specialists who provide this service, and Wholesale Investor is one of them. WI Capital, a subsidiary of Wholesale Investor, facilitates the secondary share offering to investors looking at investing in the unlisted markets. The idea is to bring the buyer and seller in contact with minimal interference from external advisors by integrating the secondary sale process into WI’s CRIISP platform thereby making it easy, less expensive and more convenient for founders/shareholders to seek exit options for their investments/holding. This service would focus not only on easing the process but ensuring high quality service and guidance with prudence and transparency.
The process implemented by Wholesale Investor is pretty simple within a secured framework:
- Potential prospect will express interest to buy shares, either via email or by filling the Registrationr of Interest form.
- You will be contacted and provided the link to the deal room where one can download and review IM, watch videos, read FAQs etc.
- Contact WI to purchase the shares or fill in the Term Sheet form in the Deal Room
- Upon agreement of terms between seller and buyer, WI will ask the buyer to transfer the funds to Escrow Account
- Share Transfer form signed
- Form to company Registrar
- Shares transferred
- Funds released from escrow to Seller
- Holding statements sent out to new shareholders
Advantage of secondary share
- Illiquidity Discount
It’s a win – win situation for both buyers and sellers in secondary sale transactions. When a buyer usually buys shares through secondary sale, the shares are offered at 10 – 30% discount of the value based on the reasons listed below. So the buyer already has upside in the investment value and as for the shareholder, liquidity is of essence.
- Transparency – When it comes to evaluating investments, public markets generally provide higher levels of transparency than private markets. Publicly traded investments offer investors multiple layers of data, including third-party research and company financials—giving investors the tools they need to make informed and confident decisions. Whereas private markets traditionally don’t surface as much data for investors—there’s generally a lack of information about an asset’s performance, its financials, and data to support the valuations. Opacity can lead to information asymmetry, making the investor worried that the position they are buying into might be a by-product of adverse selection. Why is the seller exiting the position and what might they be hiding from me? Etc.
- Volume: Private markets typically lack the necessary volume of buyers and sellers in secondary markets to allow for efficient price discovery. For example, if a large investor decides to sell a significant stake in a privately held asset on the Secondary Market, there may not be enough investors (buyers) who are evaluating opportunities to buy the entire position. Conversely, since there’s little volume in the market, buyers may not want to spend the time and effort to evaluate an opportunity. Given this lack of competition in the market due to lack of liquidity, whenever a seller wants to exit an investment, the discount acts as an effective means to facilitate transactions.
Though they don’t have the liquidity of shares on the ASX, the unlisted companies are valued at lower price-to-earnings ratios (PEs) than listed shares. Also many times, minority discount or marketability discounts are applicable because a minority interest lacks the advantages attributable to a controlling holding. Various other discounts can be applicable in secondary sales depending on the company and the performance. Valuation/pricing of investment through secondary sales is definitely an advantage for an investor.
- High Risk High Return game
Many firms are focusing on growing – in size, reputation, or otherwise – before listing and some of the world’s most popular tech giants e.g. Spotify or Uber became multi-billion dollar leaders before they eventually listed.
As more firms are deciding to stay private for longer, more value is to be found among unquoted companies and it could be argued that the potential reward more than justifies the risk – that is, when accessed through an appropriate investment vehicle.
We hope this article was useful for understanding secondaries and WI’s Secondary Market Service.
If you are a seller looking to liquidate your holding in an unlisted company, please register here and we will get in touch with you shortly. And if you are an investor, please register here your interest here to explore secondary sale offerings. Post registration we will provide you the list of secondary share opportunities.