Covid-19 has had a cascading effect on ordinary life, the economy and the investment world. One important intersection of these three is in the secondary trading market for private company shares. This is a market characterised by illiquidity, meaning people who own shares or options in these companies have no way of monetizing these shares until a “liquidity” event like an IPO or sale of the company occurs, and the secondary market provides that much needed early liquidity alternative for these shares.
As things are beginning to open up, we are seeing a very interesting dynamic emerge.
More than any other time in our lifetime, a whole new approach to investing is taking hold. There are two extremes to highlight: (1) compression of the timeline for economic change and (2) bifurcation of secondary markets. First, today’s investment calculus involves re-imagining what life will be like, not only for the short run—until an effective vaccine emerges —but also for the ‘new normal’ that this virus will leave us with. This remarkable disruption in daily living has caused investors like my Liquid Stock fund to really focus on which companies are suited to meet the needs of society. The rapid adoption of Zoom comes to mind.
Second, bifurcation has always reigned in a secondaries market characterised by the ‘haves’ and ‘have-nots’, and this is even more obvious now. The ‘haves’ are typically companies that have such an excellent public profile, positive tailwinds and a clear path to IPO that secondary investors are willing to jump in, even with extremely limited disclosure and access to information. Historically, companies like Facebook, Twitter, Uber and AirBnB had substantial secondary demand and trading despite limited public disclosure.
Today, the demand in the secondary markets is even more concentrated towards the ‘haves’. Investors are interested only in those companies that they think will “obviously” benefit in the new normal. For example, companies that provide online learning like Coursera, or delivery services like Instacart, are garnering the most aggressive attention and trading right now in the secondary markets. Otherwise they are acting with extreme caution and patience, carefully selecting the new post-covid ‘haves.’
Sorting Through the Wreckage
For secondaries, where it gets really interesting are those ‘haves’ who also ran aground during the pandemic. One of the more fascinating illustrations is AirBnB. Growing rapidly and on the verge of a massive bellwether IPO, AirBnB has been derailed and dramatically impacted during the covid crisis. The company announced massive lay-offs after revenues were down 90 percent in April and revenues expected to be down by half in 2020 versus 2019. AirBnb went from one of the hottest companies in the secondary market to nearly untouchable. We all expect AirBnB to emerge from this crisis, especially after its recent cash infusions, but valuing the company today is extremely difficult given the uncertainty of travel. The question is when.
Meanwhile employees and shareholders who own options and shares have lost their patience. Whereas a few months ago shareholders would be sticklers on price, preferring to hold out for the IPO if they didn’t get what they wanted, we are now seeing more focus on getting liquidity, and economic security versus price optimisation. The combination of the heightened need for liquidity to cure near-term anxiety, and the likely longer wait for exit, have really catalyzed the supply side of the secondary markets.
Investors willing to wade in during these uncertain times will find discounts to previous valuations. Even the most aggressive investors are treading lightly, however, as the uncertain economy presents substantial risk. Investors also have to deal with the issues stemming from their past investments, so there is limited time and appetite for new deals. Funds with substantial dry powder are showing up the most aggressively.
Pencil sharpeners may be a prudent (metaphorical) investment as we expect this substantial supply and lighter demand imbalance to last for some time. Investors will slowly update their investment thesis, but tighten their underwriting and make their bets in the secondary market very selectively. From a valuation perspective, secondary investments are far riskier than typical primary preferred deals, because they have no downside protection. Pricing in the secondary markets is going to have to adjust to this supply demand imbalance before the market will come back to pre-covid levels.
One more consequence: the major contraction on the demand side of the secondary markets, combined with the spike in supply, is pushing employees and shareholders of private companies towards new solutions, such as non-recourse stock financing solutions like what we offer at Liquid Stock. Following the initial lull, our fund’s dealflow is now up because employees are drawn to the ability to use their stock for liquidity, to cover their exercise price, pay their taxes or just get cash for living without having to sell their shares at a discount, and without having to risk personal assets.
Ultimately, both sides are looking for that rarest of things in today’s environment: deals and solutions that grant peace of mind.
Greg Martin is a partner and co-founder at Liquid Stock and has been a venture capital investor for over 20 years focusing on early, growth stage, and secondary technology opportunities. Prior to Liquid Stock, Greg held roles with Brentwood Venture Capital and Redpoint Ventures and he currently runs two other platforms in the space: entry-point investor Archer Venture Capital and merchant bank Rainmaker Securities.