Demystifying private markets liquidity in 2023

At the institutional debt and equity levels, over-the-counter (OTC) trades have long allowed for liquidity following primary issues—albeit, liquidity with less transparency compared to public markets, prior to a final maturity payment or IPO. Across debt, investors come across odd-lot sizes under $1 million, which often trade differently than institutional lot sizes.

This same anomaly also occurs for single-name private stocks, frequently when an employee leaves the capitalization table for hundreds of thousands (rather than millions) of dollars; it is typical that their transaction would come with a final price lower than their earlier or more senior colleagues with millions traded per transaction.

ApeVue, an independent private markets data provider for institutional investors, observed an average size—including bids and trades—of about $12.5 million across a diverse dozen of the more liquid secondary names in 2023; issuers included Epic Games, Revolut, Databricks, SpaceX, and Flexport. Quantifying market depth here is key for institutions seeking liquidity and price accuracy, as a growing number of retail transactions obfuscate reality for asset managers.

Albeit a different construct to how special purpose vehicles (SPVs) afforded the mass restructuring of mortgages pools, there’s separately a growing use for SPVs in private equity markets today that add to retail noise. Many recent private equity SPVs arguably bring more fragmented pricing to the market since the intent is not to tranche up varying cashflows for risk-weighted returns—as was done for mortgages—but rather allow for exposure at smaller client lot sizes. The simplified diagrams below compare an asset-backed security (ABS) SPV to an equity SPV*:

*Not all SPVs are built for the above construct, but this trend has grown to be significant.

There are several factors at play to be aware of on the equity side. The tranches sold through the vehicle are much smaller than the original stake, which may have traded as a normal institutional lot size, thus landing the originator directly on the capitalization table as a single $10 million or more “example size” line item.

Another comparison worth exploring when it comes to SPVs is who could be left holding the proverbial bag of asset/liability inventories. In the 2007–2008 mortgage market, Lehman Brothers and Bear Stearns were the bag holders

Underlying, however, there could be hundreds or thousands of participants with varying price points and terms—e.g., upfront fees and/or carried interest. Though the original entry example price at a $10 million size may be at a reasonable market-clearing price, these smaller resultant lots thereafter add an abstractly different view of the markets if used in liquidity or pricing measurement.

Another comparison worth exploring when it comes to SPVs is who could be left holding the proverbial bag of asset/liability inventories. In the 2007–2008 mortgage market, Lehman Brothers and Bear Stearns were the bag holders. Each firm held significant exposure to low-quality mortgage pools, which quickly deteriorated in value before the banks could unload the structured bonds to asset managers serving the general public, often with ratings as high as AAA.

The SPV process in private stocks today is less regulated, less understood, and substantially smaller. Stock issues will not come with a rating from the major agencies, which can of course speed up the time of structuring a large stock holding into many smaller SPV tranches, but marketing to retail investors who are also considered accredited truly takes time. In a declining market, this can be fighting the clock.

One of the saving graces of private markets historically has been that the last round valuations are outwardly marketed and used as today’s price, no matter how long ago this has occurred.

Coming full circle on liquidity, it is clear that in today’s secondary market, there are almost no buyers/trades at the last round price. If there is one takeaway on understanding pricing coming into 2023, it should be to focus on where institutional prices imply valuations.