​While public stock markets generally grab the headlines, investing in privately-held companies is growing faster than public marketplaces. Crowdfunding, angel investing, increased retail participation and sophistication, and a desire by institutional and retail investors alike to gain exposure to companies earlier along their growth curve, before they go public, are all contributing factors.

But there’s one segment of the private markets that has historically excluded all these investor groups: so-called “pre-IPO giants”—major companies that remain privately held, with their stock tied up by a typically small number of investors.

“People think of the public markets as the marquee venues … but investing in public markets has gone down year over year, while investing in private markets has gone up over the same period,” says Carlo di Florio, partner and global chief services officer at New York-based compliance advisory firm ACA Compliance.

This increased cash flow into private companies follows initiatives by the US Securities and Exchange Commission to make private markets less risky for investors. “The reason regulators have been reluctant to expand access to private markets in the past was to protect investors,” says di Florio, who previously served as chief risk and strategy officer and executive vice president of shared services at Finra, prior to which he was director of the Office of Compliance Inspections and Examinations at the SEC.

While at the SEC, di Florio was involved in regulation and registration of hedge funds and private equity firms, which required these companies to provide the regulator with information about their structures and holdings. This “rich dataset” from those filings created “a pretty robust and efficient framework … to protect investors in these private markets,” he says.

These measures provide protection against smaller, higher-risk private companies. But even for established broker-dealers and individuals certified as accredited investors wanting to participate in pre-IPO trading in larger, lower-risk companies, significant barriers still remain: specifically that existing shareholders—usually management, staff, and private equity firms—want to retain their stock at least until a company IPOs.

“The late-stage venture asset class is a $2 trillion market, and a lot of that is executives and employees sitting on their stock,” says Marcus New, CEO of Vancouver-based InvestX Capital. One reason for the growing interest in this market is that 2020 saw many of these pre-IPO giants doubling their set IPO price once they decide to go public. “So far, these late-stage, private-equity-funded companies have only been available to a small group of large investors. … These private companies have been staying private longer—and that small group of investors have been the beneficiaries.”

New tools

That’s where InvestX comes in. For seven years, the company has been acquiring holdings in these companies and creating a marketplace for that slice of stock among broker-dealers, who can then offer the stock to their investor clients. Now, the firm has released a technology platform, dubbed Gem, which automates parts of the process by which these firms trade and settle these securities.

According to New, the challenge of accessing liquidity in these large pre-IPO companies isn’t even the biggest hurdle facing firms: The biggest problem for these broker-dealers, he says, is integrating any trading in private securities into their existing records systems in a compliant manner. “Most sell-side firms are trying to figure out how to get into this market. They see this as a massive asset class,” he says.

To do this, InvestX developed a proprietary protocol that integrates with firms’ existing back-office systems and fits their normal processes “like a glove.” And it’s not that firms are unfamiliar with investing in private equity funds or handling private placements and Reg D filings, but rather that they function differently, and “firms don’t like to deal with them because they are not electronic. Gem helps brokers electronify all those back-office processes. We standardize them, so everything works for the dealer,” New says.

Automating these processes enables brokers to more easily process private securities in the same way that they would listed equities. Once that is achieved, more brokers would be technologically able to participate in the markets. “And more sell-side participants naturally generates more liquidity,” New says.

Automation also enables the creation of electronic price discovery in a hitherto opaque market. This benefits not only brokers and investors seeking exposure to those stocks, but also those who currently hold stock in private companies but don’t have a way to value their holding or to know what price is a fair offer for their stock.

Broker participants can access Gem’s price discovery platform, which operates in a private environment for its participants—though the company also plans to make data available via third-party vendors—and includes a Level 2 screen similar to what traders would be familiar with for on-exchange trading, and an auction mechanism.

Obtaining reliable data—let alone liquid prices—on privately-held companies is a challenge at the best of times, says Sara Dillon, senior vice president and head of private markets at FactSet. “Data in private markets is disparate and difficult to capture. It’s like trying to piece together a 10,000-piece jigsaw puzzle.” In addition to providing data on exchange-traded and over-the-counter (OTC) markets, FactSet also provides coverage of private companies, private capital, and M&A activity among privately held companies.

“When trying to evaluate a private versus a public company, you want the same data; it’s just much harder to find [on private markets], because it is not filed in the same way. So vendors have to find a source, or find a way to accurately predict that,” says Dillon, who joined the vendor last year to focus on its private markets datasets. “Part of what I’m doing is bringing it together and making sure it’s client-ready.”

Creating automation, which begets participation, which in turn begets more liquidity, data, and transparency, will also contribute to driving down the cost of participating in the private equity markets, New argues. While there are options for employee stockholders to cash out their private stock, these can come with a high commission cost. “We believe the market is over-inflated for a reason—because it is not automated … and because it’s lucrative for others to keep it that way,” he says.