Secondaries upstarts: A tool for the ‘asset rich and cash poor’

The direct secondaries market has established itself as a useful tool for company founders and early investors to gain liquidity.

Direct secondaries transaction volumes stood at $17.43 billion in the first half of this year, according to data from intermediary Setter Capital, a 27.8 percent year-on-year increase.

There are, however, potential downsides. For the seller, offloading a stake in your own company means giving up potential upside and sometimes voting rights. For the private equity or venture capital firm backing the company, a founder or employee cashing out all or part of their position can be bad for alignment. Will someone who has just received a big windfall have the same drive and focus as before?

London-headquartered Collective Equity Ownership, which counts CrowdCube founder Darren Westlake among its non-executive directors, was formed with these challenges in mind. The startup is raising up to £30 million ($39.6 million; €35.5 million) for CEO I, a fund based on the principle of collective equity ownership.

Two parts equity, one cash

In the words of founder Archimede Mulas, a naval architect by training, collective equity ownership means shareholders of private companies “pooling their shares together to unlock illiquid wealth“. A minimum of 12 company founders commit a portion of their holdings to a fund, creating a diversified, commingled pool. The proceeds of exits, dividend payments or special bonuses are shared among the investors, so participants do not need their own liquidity event in order to generate cash.

Potential investors are told how much the other companies in the pool have raised, who their investors are and which investors have doubled down. CEO is privy to information such as financial performance, which it keeps strictly confidential.

Participants must be UK companies, tech-enabled and must have raised more than £5 million, Mulas explains.

A maximum of 30 percent of CEO I will comprise cash. This will go straight to the equity investors on the fund’s close, giving them upfront liquidity equivalent to 15-25 percent of their equity stake. In return, the cash investor receives a 1.25x preference on returns from the fund; CEO I only has to perform modestly for the investor to get their money back. 

“The cash investors see this as an opportunity to participate in the asset class without having to be an LP in a VC fund,” Mulas said. “We are unlocking and de-risking the asset class.”

Network effect

To gain buy-in from equity investors, CEO has targeted founders directly and via entrepreneurs’ clubs and associations, including the British Private Equity & Venture Capital Association. The members of these groups are likely to know each other and understand one another’s businesses, providing the foundation of trust needed to throw one’s lot in with the others.

Interest in being a cash investor has mainly come from family offices and high-net-worth individuals. As of early November, CEO had received a few soft cash commitments and one hard commitment. CEO I is targeting a first close at the end of January with the participation of 10 equity investors, Mulas said.

For now, the fund is UK and VC-focused. Mulas said he sees no reason why the model cannot work in other geographies or with other illiquid assets, such as LP interests, art or real estate. It is a “solution for anyone who is asset-rich or cash poor”, he said.

There are questions to be answered. While founders may be keen to share in the liquidity events of companies they know well, can they get comfortable with less familiar names? Early-stage companies have a small chance of a successful exit, but that exit could be huge. Are shareholders willing to exchange the dream of a big payday for a steady stream of returns?

Mulas, who admits new ideas can take time to catch on, is positive about CEO’s potential.

“There’s a learning curve around this, but it’s starting to get traction.”

Read our profile of secondaries upstart Rivver – the Israeli firm that wants to replace intermediaries and lawyers – here.