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The Third Exit Point

What you need to know about the secondary markets of Venture
Capital: Interview with Eric Thomassian, Director of Investment Sales at EquityZen.

EquityZen Inc. is a rapidly growing marketplace for investing in late-stage private technology
companies. EquityZen provides accredited investors, wealth advisors, and institutional
money managers access to private markets through actively managed funds and single-
company funds. With over 11,000 private placements completed and 200+ premier private
companies served, EquityZen is building private markets for the public. EquityZen is backed by
leading Wall Street and Silicon Valley firms, including Draper Associates and WorldQuant

The top quartile of venture capital investments have on average, outperformed the S&P 500 by 2-3x over 20-25 years. What do you believe is causing this outperformance? 

Private equities are traditionally considered high-growth, risky investments, because they are illiquid and require longer holding periods. The venture capital industry aims to outperform the public markets to compensate for the risky nature of private investments. VC firms use a home run investment strategy. They take a bet on young startups when valuations are low, with the understanding that only a few investments will survive and generate outsized, positive returns. Additionally, venture capitalists participate during the private growth stages where a majority of corporate value appreciation is now also taking place as companies stay private longer. 

The Alumni Ventures Group issued a white paper report in December 2019 on venture capital returns benchmarked against the S&P 500 and Russell 2000. The data shows that the top quartile of VC firms generated superior returns. Over the course of 25 years, top-quartile VC firms generated returns of 18.9% to 25.1%, whereas the public markets returned less than 13%. These returns illustrate the importance of a diversified portfolio, where the risks and returns of different asset classes are balanced. 

In 2004, companies typically went public after 4 years, today the average company IPOs after 10+ years. Why in your opinion companies are staying private for longer? 

There are two factors that have caused companies to stay private for longer: (1) increased funding in the private markets and (2) the JOBS Act of 2012.

Up until the Great Recession, the public markets were conducive to initial public offerings. Companies leveraged the bullish market to maximize proceeds and valuations. The Great Recession, though, caused the public markets to falter. Economies and stock markets were slow to recover. Investors seeking higher returns funneled their money from the public markets to the venture capital industry. As a result, companies had easily accessible private capital, reducing the need to go public. Companies operating in the private markets are also able to maintain more control and limit the administrative burden, foregoing regulatory scrutiny public companies endure and avoiding having to appease Wall Street’s quarterly earnings expectations. 

Congress also passed the JOBS Act of 2012, which expanded the limit of accredited investors from 500 to 2,000 and excluded employees in the investor limit. The JOBS Act was meant to promote job creation and economic growth by easing restrictions in capital markets for startups. The legislation allowed companies to raise additional venture rounds and grow headcount without hitting the investor limit and having to go public. 

Why invest in Pre-IPO equity, a $500 billion market? What types of pre-IPO asset classes do investors on EquityZen platform get access to? 

At EquityZen, we seek to democratize private asset classes by making them accessible to all. As companies stay private for longer, investors have lost access to high-growth, mature startups. Leading up to the Dot Com Bubble, companies generated most of their value in the public markets. Fast forward to today, value is primarily created in the private markets. See here for a chart depicting the change in valuation creation over time. Through EquityZen, accredited investors can participate in the private value creation by investing prior to companies’ IPOs. 

Most investment opportunities on EquityZen are in startups, many of which are “household names”, who have received institutional financing from well-known late-stage or growth funds that have a typical investment horizon of 2-5 years. As with most alternative asset classes, there are certain risks to investing in Pre-IPO equity, such as indefinite holding periods and opaqueness of company information. However, we believe that for certain types of investors, Pre-IPO equity can play an important role in formulating an adequately diversified investment portfolio given the non-correlated nature of many investments on our platform. 

The pre-IPO asset class spans industries such as: enterprise software, healthcare, biotechnology, logistics, food-delivery, and more. Almost 200 companies globally have a private-market valuation above $1 billion and the largest 15 are collectively valued at $300 billion. To date, EquityZen has worked with over 200 companies and has closed over 11,000 company-approved investments.

Please share with us more information about some of the recently transacted deals on your platform. What makes these secondary market deals so successful? 

To illustrate the type of opportunities an investor may have access to via our platform, we previously transacted in companies such as DraftKings and Spotify, both of which have since gone public. 

Although not all pre-IPO investments will necessarily be successful, and investors can lose all or some of their investments, investors are often able to take advantage of the fact that early stage employees, as well as other types of shareholders, looking to monetize their equity through our platform are willing to sell their shares at a discount to the most recently priced round because they have often obtained their shares at a greater discount and have a need for liquidity. These sorts of pricing dislocations can present excellent investment opportunities. Also, there is an access element, where an investor simply wouldn’t be able to invest in a particular company without leveraging the secondary market. 

How is EquityZen Growth opportunity fund selecting which companies to invest in? Please share with us some of your success stories / Exits. 

Our flagship managed fund strategy, EquityZen Growth Opportunity Fund, targets 15 to 25 investments in aggregate. The investment committee looks for opportunities to capitalize on pricing dislocations as described earlier, while also taking into consideration other factors including, but not limited to maturity of the company, notable investors, revenue, revenue growth, background of founders, market size and competitive advantages. 

With respect to previous vintages, we have had some successful outcomes. For example, in GOF5: DraftKings (DKNG) began trading on the public markets on April 24, 2020 following the completion of the previously announced transaction with Diamond Eagle Acquisition Corp. and SBTech, an international provider of sports betting and gaming technologies. The shares held by the Fund are subject to a lock-up. We anticipate this will expire in September 2020. We confirmed with the company that the conversion ratio for private DraftKings shares is 0.353628. By way of example, this means that every 10 shares of private DraftKings stock represents 3.53628 shares of public DraftKings stock. The effective cost per share of the Fund’s investment is $9.20. As usual, once the lock-up is lifted, we will distribute cash proceeds based off pro rata ownership in the fund. Unrealized return as of May 31st, 2020: +331% GOF2: Spotify (SPOT) went public on April 3rd, 2018 and opened at $165.90 per share. The Fund purchased ordinary shares at $2100.00 per share (inclusive of transaction fees). In connection with its IPO, Spotify conducted a 40-to-1 stock split, resulting in an effective cost basis for the Fund of $52.50 per share. As Spotify’s IPO was a unique event—a direct listing—there was no lockup period. The shares were promptly sold in the open market at a price of $166.66. Distributions were sent to investors on April 19th, 2018. Realized return on position: +217%. However, not all exits will yield such successful results. 

How can investors invest with EquityZen platform / in your VI fund?

If investors would like to explore our multi-issuer and single-issuer investments, and see what opportunities are available, they can simply go to EquityZen and create an account.

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