Regulators, startups eye transparency efforts for private companies

Trading stock in privately held companies that have not yet listed on exchanges has exploded—as detailed in WatersTechnology last year—creating a raft of new marketplaces and datasets offering trading access and insight into the value and behavior of private stocks. This movement has also prompted efforts to deliver greater transparency into these markets by regulators and new vendors alike.

Leading the charge is the US Securities and Exchange Commission (SEC), which is planning to step up its scrutiny of private markets. Last year, commissioner Allison Herren Lee gave a speech calling for greater transparency to address the “explosive growth of private markets,” which for the past decade have raised more capital each year than on public exchanges.

For example, in 2019, private offerings accounted for 70% of new capital raised, while the number of so-called “unicorns”—privately held companies with a value of more than $1 billion, and in some cases, so-called “hectocorns” with valuations as high as $100 billion—rose from around 39 worldwide in 2013 to some 900 last year. With such companies staying private longer and growing more valuable before investigating an IPO, commissioner Lee warned that “we are again watching a growing portion of the US economy go dark.”

By this, she meant that a large and growing part of the US economy is opaque to potential investors because privately held companies are not required to file reports or disclose financial information or audited statements in the same way as publicly traded companies, meaning there is little public information available about these potential investments. “This has consequences for investors and policymakers alike, which in turn may have consequences for the broader economy,” Lee said at The SEC Speaks event last year.

Dr. Richard Smith, an author who is also the CEO and chairman of the Foundation for the Study of Cycles, tells WatersTechnology that interest in private markets is partly being driven by activity in public markets. “Last year, two-thirds of companies that IPOed were trading at below their market value,” Smith says, citing popular trading app Robinhood, which—albeit as a result of some turmoil—IPOed at $38 and peaked at $55 on August 6, before dropping to $15.52 on January 13 this year.

And though the amount of data available is growing, Smith says the overall lack leads to questions about its quality. “I think there is more data available than is actually being leveraged right now. But a lot of the data that is being used is poor quality. So, we need a new way of sharing data so everyone can benefit—including the sources/generators of that data,” he adds.

The lack of available information also creates significant challenges for brokers seeking to provide investor access to private markets, says David Hartzell, senior analyst at Santa Monica, Calif.-based Park Lane, an investment bank and capital investor.

“Accredited investors/qualified purchasers are smart, savvy, and well-read, and often require decks and data rooms to make educated decisions,” he says. “Unfortunately, a lot of the most popular names … have little to no data access—aside from a possible former founder or employee willing to opine on where they think the company is headed.”

He says that even when information on these types of companies can be found, the sources are fragmented, and institutional investors, high-net-worth individuals, family offices and sovereign wealth funds “often consider it a non-starter if they can’t see data,” which makes it difficult to effectively make markets in high-demand names.

To quantify the impact of that lack of data on trading, Alex Zykov, managing partner at New York-based investment bank and strategic advisory firm Argo Capital Partners—which participated as a special-purpose vehicle sub-advisor in private-stock technology provider Carta’s $215 million series-F fundraising round—says that between one-third and half of all potential trades are not completed because of a lack of either price transparency or due diligence information.

“Unless you are dealing exclusively with hedge funds that are willing to make trades ‘thematically’ and hedge their bet elsewhere, investors want some level of info to wrap their head around how a given private company compares to public comps or other similar privates in terms of financial performance, growth, etc.,” Zykov says. “In those instances where the seller has info (or the trade comes from/through management), even those who are transacting in the secondary market for the first time can get comfortable enough. Without that, folks feel like they are operating in the fog, even if they have some parameters around valuation.”

In many cases where existing data providers carry data on private companies, that data includes reference and fundamental data, and even information on funding rounds, valuations, and possibly some business metrics, but not indicative price data.

“There are platforms that provide information on funding rounds, such as Forge, EquityZen, etc., but none show what’s happening in between,” in terms of price data that funds and asset managers can use to mark their investments over time, or the kinds of high-level financial data they desire, such as historical and/or projected revenues, profitability and cash burn, and other key performance indicators, like number of locations, units sold, customer numbers, and more, he says.

But when it comes to price data, much of that was generated in a fragmented manner by brokers based on their trading activity.

Filling the void

It was while helping his brother secure a job with a broker in the pre-IPO space that Nicholas Fusco realized that although the private markets were on a roll, they lacked an independent, third-party pricing source. Fusco recognized the similarities between the evolution of the private stock markets and the early days of credit default swaps, syndicated loans and collateralized loan obligations from his 13 years at Markit and IHS Markit, and saw an opportunity to fill that gap.

The result is ApeVue, a New York-based startup of which Fusco is founder and CEO. Since the vendor’s inception last March, Fusco has secured agreements with four brokers to provide price data from anonymized trading activity, which the vendor then normalizes to provide aggregated prices for privately traded stocks, which clients—contributing brokers and others who can subscribe to its data—can use to perform risk management or calculate net asset values (NAVs).

The service currently provides daily prices for around 100 private companies based on a weekly batch-pricing process, and Fusco says the company aims to provide same-day pricing for most—if not all—names covered.

Contributing brokers supply bids, offers, and traded prices via a template, then ApeVue extracts the data and cleans it to remove outliers and normalize the data—a challenge in itself, since some brokers quote in stock price and others quote market value, while all use different naming conventions. Then the vendor runs the numbers through a Python script and then filters them against its own requirements around price and size to ensure it is producing quality prices based on institutional-sized trades that would be useful to asset managers. ApeVue makes the data available to contributors and subscribers by exposing an API, or as a CSV file via email. By the end of March, the vendor plans to offer a user interface that will provide more features, such as dynamic charting and sector comparisons.

“One of the most important things is providing data that is more timely than three months or six months old,” Fusco says. “We’re exclusively market data-driven. We’re providing what we believe is a better price for the inputs you use to price NAV or to use as a comparable. We don’t use comps in our pricing—that’s a fundamental differentiator between us and other pricing providers.”

The data inputs by definition are different from the data produced by traditional listed markets because the way the markets operate are different, says Hartzell at Park Lane, which has been one of the early contributing brokers to ApeVue’s service during its beta period.

“These trades are often complex, and it’s not uncommon to put months of work into one trade. Unlike Robinhood or other digital platforms in public stock trading, this is still a complex landscape that requires a handful of skilled humans to effect the trade legally and accurately. ApeVue and a few others have made huge progress in data aggregation. The composites they’ve built are only going to get better and more user-friendly as they are fed more information. They’ve built out charts, ticker symbols, and historical data that is catnip for analysts.”

Smith also believes the latest developments are a move in the right direction for private markets seeking to achieve greater transparency, but says meaningful change may still be five or so years away, and may require incentives to encourage—rather than enforce—public disclosures by non-private companies.

“Greater transparency and data collection are moves in the right direction—and I think those are inevitable. There has been a lot going on in terms of new exchanges coming online to give us access to loads of data on different assets. I believe that trend will continue and will allow for better price discovery,” Smith says. “And I hope that the SEC defines the rules a little better to help these new trading venues become more valuable to the public.”

One such new trading venue is Securitize Markets, an ATS for trading privately held securities created last year by Securitize, whose main business thus far has been navigating private companies through the process of issuing and digitizing private stock.

“The challenge in this space that we’re trying to solve for is that there’s a general trust issue compared to the information available in public markets,” says Securitize Markets CEO Scott Harrigan. “The regulators have come to realize that it’s a $7 trillion growth market, and they are cognizant that they need to put as many rails around private securities as exist around public ones. Now, what you see is regulators requiring a greater level of public disclosure [from private issuers] to ensure investor protection and that investors are making decisions with all the available information.”

Thus, he welcomes greater regulation and disclosure requirements, as well as market-led efforts such as ApeVue, saying that making more information available will only help increase investor confidence in private markets, where data thus far has been largely limited to pricing based on a company’s last round of fundraising, and not interim—let alone real-time—observable data.

Another way to build out that kind of data is to create a marketplace for private securities, where dealers make markets in stocks, and investors can see a record of executable quotes and traded prices. So in late 2020, Securitize acquired Distributed Technology Markets, a registered broker-dealer and ATS, which—once Securitize built out back-end systems and a front-end user interface—became Securitize Markets.

“The distinction for us is that we have control over the supply, and the ability to create our own supply. We have a number of private issuers and funds looking to digitize their assets. And when those assets become available to trade, the natural choice will be to trade then on our ATS, because it’s all part of the same ecosystem,” Harrigan says, which in turn will create datasets that—while “still not at the level you’d expect from public securities”—go some way towards creating exchange-like transparency. “We’re building out real-time transaction data on the platform, and at some point, we’ll be able to push that out in a more useful way, which will increase investor confidence.”