Saeid Hamedanchi, is a registered representative of Rainmaker Securities, LLC, a FINRA/SIPC registered broker-dealer. He can be contacted at shamedanchi@rainmakersecurities.com.
LOS ANGELES — Traditionally, investors seeking exposure to corporate securities gain such exposure through investments in publicly traded companies, where transaction execution is standardized and liquid markets exist. In the past, the universe of investment opportunities traded on public exchanges has been broad enough where investors have been able to find a full spectrum of risk/reward opportunities that match their portfolio strategies.
However, the investment universe has undergone a sea of change since the Great Recession. A low interest rate environment, combined with a collapse of equity prices, led capital that was formerly invested exclusively in the public sphere to seek opportunities for yield in private securities. The result has been that companies that have reached a developmental milestone where listing their securities on a public exchange was their only path to raise sufficient capital for growth could now access large pools of investment capital without the necessity of a public listing. Consequently, given the regulatory overheads associated with being a public company, along with talent retention challenges that surface once employees can freely trade their equity compensation, many companies that in a prior era would be publicly listed, have chosen to remain private. Evidencing this trend, on inception, the Wilshire 5000 Index tracked 5,000 constituent securities; however, as of the date of this publication, the Wilshire 5000 Index now comprises only 3,465 constituents.
A corollary result is that investors seeking equity investments in many of the world’s fastest-growing technology companies cannot use the public secondary market to participate. In reaction, the private equity secondary market has been experiencing rapid growth. Like the public equity secondary market, investors are buying already issued stock in companies. However, because private companies are not publicly traded, the mechanisms by which to transact, the pricing environment and the amount of information available to investors are not standardized.
THE UNICORN CLUB
The seminal event in the growth of the private secondary market was the trading marketplace that developed around the first ‘unicorn’ prior to its public listing – that unicorn was Facebook.
In the subsequent five years since Facebook’s IPO, the ‘unicorn club’, which comprises all venture capital-backed private companies which have been valued in their last venture financing round at a valuation of US$1 billion or more, has grown from one member (Facebook) to 197 members as of the date of this publication, according to CB Insights. These companies have collectively raised a staggering US$127 billion via private venture capital funding rounds, with well-publicized mega rounds by the likes of Airbnb (US$3.9 billion in total), Didi Chuxing (US$8.5 billion in total) and Uber (US$12.5 billion in total), according to Venture Beat.
Importantly, this means there are 197 leading companies, comprising a diverse array of disruptive technologies, holding dominant positions in their respective verticals and/or geographies, with proven business models and rapid revenue growth that cannot be transacted via a public exchange.
These leading companies cover a broad variety of industries such as ride-sharing, home-sharing, office-sharing, space exploration, cloud computing, artificial intelligence, financial technology, mobile computing and others. Consequently, the secondary market for shares in unicorns is booming. According to recent estimates, the market value of secondary share transactions involving the unicorn club was US$35 billion in 2016 compared with US$11 billion in 2011, according to SharesPost.
INVESTMENT CASE
According to the Cambridge Associates Growth Equity Index, funds that employ late-stage venture investing strategies have produced 10.57% and 14.3% returns for the past 10 and 25-year periods respectively, versus 6.95% and 9.17% for the S&P 500 index respectively. Several unicorns have turned into household names, dominating new markets that didn’t even exist 10 years ago. A sample case in point is the ride-sharing market. Ride-sharing companies have raised approximately US$25 billion since 2010 and enjoy a combined market capitalization of US$120 billion and the estimated size of the ride-sharing market is expected to reach US$600 billion, according to NASDAQ. Five ridesharing companies dominate the global marketplace and they are expanding rapidly in major geographies including the US, Asia and Europe. The rapid growth is due to offering innovative and disruptive technology focused on providing high customer satisfaction and competitive pricing, leading consumers to opt out of traditional transport services (such as taxis) and even car ownership. This value case has fueled the rapid growth of ride-sharing companies around the globe.
INVESTMENT CONSIDERATIONS
Key considerations of investing in late-stage companies via the private secondary market are:
Investor benefits:
Seller motivations:
Issuer motivations:
Challenges:
COMMON TRANSACTION STRUCTURES
The two most common structures for transacting in late-stage secondary shares are:
The two common structures have the following advantages and disadvantages:
CONCLUSION
Investing in unicorns is likely to be a higher beta strategy than investing in a broad equity strategy such as the S&P 500 Index. Additionally, because secondary markets in unicorn shares are non-standardized in terms of execution and available data, and markets are opaque in nature, transacting is more complicated, and liquidity options are fewer versus transacting in the public equity marketplace. However, investing in unicorn shares can be a powerful alpha in a well-diversified portfolio. Many unicorn companies dominate their respective markets, with proven revenue models, extraordinary revenue growth and correspondingly strong value creation.
DISCLOSURES
Private equity involves risk-sharing between investors, entrepreneurs and company management. Also, from our analysis, many verticals are in Shariah permissible business activities such as office-sharing, ride-sharing, home-sharing, information technology and mobile computing, among others.
Shariah compliant investing requires that certain financial ratios are tested to ensure that the companies are compliant with Islamic investing principles. In the global public equity markets, companies are required to disclose their financial statements to regulators and the investing public in a transparent manner. However, in private equity secondary markets, due to a lack of disclosure requirements, conducting ratio analysis can be very challenging. However, based on our research, we believe that most unicorns do not use a high amount of leverage, and so on this metric, would likely be compliant. However, we are not in a position to attest to Shariah compliance for many unicorns because of a lack of required financial information. We believe that investors should do their own analysis to determine which of these companies are indeed Shariah compliant.
Securities offered through Rainmaker Securities, LLC – a registered broker-dealer, member of FINRA/SIPC. 11390 W. OLYMPIC BLVD, SUITE 380, LOS ANGELES, CA 90064. Investment opportunities listed with Rainmaker Securities involve a high degree of risk, and are only suitable for ‘accredited investors’ as defined by the US Securities and Exchange Commission. All investors are encouraged to seek legal and other professional counsel prior to making any investments.
SOURCE Rainmaker Securities, LLC