Hoping to revolutionize secondary private equity fund transactions the same way online brokerages affected stock market trades, PrivateTrade Inc. plans to launch the first Internet-based exchange for the secondary marketplace within the next few months.
In conjunction with the opening of the online exchange – which it expects will go live by the end of the first quarter – the eight-month-old San Francisco-based firm has a $10 million Series B venture capital offering in the market that it hopes to close by early April.
PrivateTrade, which was founded by a group of investors last May, declined to comment on its first round of VC financing.
In some respects, PrivateTrade couldn’t have picked a more opportune time to come to market. Spurred largely by the public market’s downturn and the consolidation of banks as a result of the shifting regulatory landscape in the financial services industry, secondary private equity transactions have become more prevalent.
Part of the reason is that banks, which have historically held significant limited partner positions in VC funds, are being forced to sell off LP interests as their private equity allocations become too large to effectively manage.
It’s also a relatively uncharted niche, as the secondary market remains small relative to the entire private equity market.
To that end, PrivateTrade sees tremendous opportunity in terms of the market’s sheer size and growth potential, said Kathleen Powers Dunlap, the company’s chief executive.
PrivateTrade estimates that secondary private equity transactions were valued at approximately $2.7 billion in 2000, although at least one industry source pegged the actual figure closer to $2.1 billion. Furthermore, the secondary private equity market has grown an average of 35% per year throughout the 1990s, from $130 million in 1990 to more than $2 billion in 2000, and could reach a projected $6.8 billion in 2005, according to company estimates.
As such, sources say secondary private equity has been touted as one of the fastest-growing segments of the financial services industry.
Streamlining the Process
Besides taking advantage of the market’s enormous growth possibilities, PrivateTrade also intends to address the inherent glitches and inefficiencies it currently sees in the transaction process. Targeted at institutional investors, general partners, portfolio advisors and placement agents, the company’s product is designed to alter the way these transactions are done.
“It’s a fragmented community,” Dunlap noted. “Sellers have limited exposure to buyers, and vice versa, which negatively effects the price [of these securities]. We can use the power of the Internet to aggregate buyers and sellers all in one community so they can communicate with one another.”
It’s also an expensive and time-consuming proposition for institutional investors to liquidate their partnerships, she added. Indeed, most transactions involve fairly large, significant shares in a fund, and thus require extensive negotiations, legal proceedings and due diligence on the part of both LPs and GPs.
As such, PrivateTrade is aiming to drastically reduce the time it takes to execute secondary private equity transactions from several months to between 30 and 60 days. It will do so, Dunlap claims, by providing a comprehensive online interaction that gives potential buyers plenty of time to adequately assess the value of the asset they’re looking to purchase.
A Five-Step Process
Essentially, the transaction takes place in five basic steps. The first is PrivatePost, whereby registered members of the site can anonymously post listings on PrivateTrade without obligation. Clients can register on the company’s Web site for a fee of $2,500 a year, although the charge will be waived for at least six months to encourage membership, Dunlap said. The company expects the marketing portion of the site to go live this week.
Under the PrivateTrade model, the seller controls the timing and the price of the interest listed for sale. However, during the second stage of the process, called PrivateScreen, the company screens all potential buyers and enables GPs to preview potential investors and eliminate those that aren’t suitable for their partnerships. The seller remains anonymous until the deal closes.
During the PrivateDiscovery phase, bidders that have received a GP’s blessing are authorized to access detailed documents in a secure data room in order to perform due diligence. PrivateTrade offers an array of proprietary analytical tools and software to assist investors in assigning the security a fair valuation. The company can also refer buyers and sellers to a third-party consultant to aid in the valuation process.
Although Dunlap recognized the difficulties of pricing an illiquid share of a fund, she cautioned that the tools are just guides for investors, and should not be the only factor in determining final value.
In the PrivateBid stage, investors submit bids any time before the transaction’s expiration date. Only pre-approved bidders, the seller and the GP may view the sales process.
Finally, the transaction is reconciled during the PrivateSettle phase, whereby PrivateTrade submits the highest bid to the seller. Settlement should take place within 10 days of the transaction, according to the company, and the proceeds are transferred offline through a bank escrow agent.
Will It Work?
Dunlap said the company is not only hoping to change the way secondary private equity transactions get done, but to help LPs seek out the best price for their fiduciaries and give them more control over their portfolio and, hence, increased liquidity.
However, some industry experts are skeptical of PrivateTrade’s model. Such a reaction is not surprising considering that online trading of non-VC private placements have a history of failure. For example, E*Trade‘s E-Offering was designed to facilitate both primary private equity and private debt transactions online, but the latter never took off.
One industry expert said he believed the transactions were much too complex to be conducted online. “These deals involve a lot of offline [interactions],” he said. “Some people are offering upwards of 80 partnerships, so [doing it all online] presents extensive challenges.”
Nick Harris of Lexington Partners agrees that the Internet may not be the best forum for trading these securities.
“We just don’t know what percentage of general partners will be comfortable with having interests [in their funds] sold over the Internet,” he said. “I think that’s one of the things that PrivateTrade is trying to figure out how to overcome – how to remove the relationship from equity. We’re curious to see what happens.”