{"id":8276,"date":"2020-12-17T19:29:57","date_gmt":"2020-12-17T19:29:57","guid":{"rendered":"http:\/\/www-staging.carta.com\/sg\/?p=8276"},"modified":"2021-03-05T06:54:03","modified_gmt":"2021-03-05T06:54:03","slug":"secondary-market-liquidity","status":"publish","type":"post","link":"https:\/\/www-staging.carta.com\/sg\/blog\/secondary-market-liquidity-and-fair-market-value\/","title":{"rendered":"Secondary market liquidity and fair market value"},"content":{"rendered":"

This article was coauthored by Andres Trujillo, CartaX.<\/em><\/p>\n

The secondary market for private stock offers companies the opportunity to unlock the value of equity for their shareholders, whether founders, employees, or early investors. By making private company equity liquid before the company goes public, shareholders can realize the value of their assets as a company grows.<\/span><\/p>\n

The secondary market for private stock functions quite differently from the public stock market. With no centralized market infrastructure, matching supply and demand comes with risk, overhead, and a myriad of limitations including transfer restrictions, little to no price transparency, less efficient price discovery, extended settlement cycles (upwards of two to four weeks), and high administrative and operational burdens on companies. As more and more capital is piling into the most attractive companies later and later into their lifecycle, the typical catalysts for going public are diminishing. This means that for early employees and investors, the time to exit is extending and as a result, pre-exit liquidity is increasingly important. Yet, its forms have remained largely unchanged for decades.<\/span><\/p>\n

Today, private market secondaries take two forms:<\/span><\/p>\n

    \n
  1. Structured liquidity programs, such as tender offers (company buybacks or third-party transactions), block sales, auctions, options repricing\/RSUs<\/span><\/li>\n
  2. Direct stock transactions, which are supply driven events that are initiated by a broker or a company\u2019s network of current and former employee stockholders\u00a0<\/span><\/li>\n<\/ol>\n

    Tender offers are the most common type of issuer-approved secondary. These are issuer-sponsored, episodic events initiated by the company, with one or multiple goals in mind like cleaning up the cap table of former employees and early investors, mitigating share dilution in connection with a large fundraising round, or supporting employee retention and talent acquisition goals in a highly competitive environment.<\/span><\/p>\n

    Since 2017, Carta has been partnering with companies seeking liquidity, delivering a solution that simplifies the execution of tender offers and company repurchases. Carta is leading the next evolution in private market liquidity with the launch of <\/span>CartaX<\/span><\/a> in the first quarter of 2021. With CartaX, issuers will be able to create a permissioned marketplace for their equity, offering them the ability to set transaction configurations, including transaction frequency, eligible participants, and eligible securities, while maintaining visibility over price formation throughout the liquidity event. As companies consider offering liquidity through CartaX on the path to IPO, they need to understand their company\u2019s valuation and the potential positive and negative implications of a secondary stock transaction to that valuation.<\/span><\/p>\n

    Since 2016, the Carta Valuation Team has completed over 19,000 valuations for tax compliance under IRC 409A and financial reporting purposes under ASC 718. The team has assessed a wide array of companies, varying from very early-stage businesses to late-stage pre-IPO companies. In 2020, our team expects to complete over 9,000 valuations, including over 1,200 companies with $50M or greater in total revenue, over 900 customers that are currently audited, and over 300 customers that are being audited by Big 4 accounting firms this year.\u00a0<\/span><\/p>\n

    Surprisingly, the most frequent question asked to the Carta Valuation Team is not related to the sophistication of the calculations in our models or how we assess the risk of a business we\u2019re assessing, but rather how secondary stock transactions impact the value of their equity under IRC 409A and ASC 718. In the past two years, the Carta Valuation Team has assessed 400+ secondary stock transactions, ranging from the most basic tender offers to direct stock transactions to distressed stock sales, using guidance from the AICPA<\/span>.1<\/sup>\u00a0\u00a0<\/span><\/p>\n

    One type of secondary transaction offered on CartaX is the Carta Cross<\/a>, a proprietary auction-based transaction that can recur monthly, quarterly, or annually at the issuer\u2019s discretion. The Carta Cross is designed for efficient auction-driven price discovery, allowing an issuer\u2019s equity holders to sell to investors permissioned by the issuer to participate in the auction.\u00a0<\/span><\/p>\n

    The valuation work completed by 409A analysts in advance of a tender offer, auction, or other secondary transaction takes certain transaction characteristics into consideration. These characteristics are evaluated against the company for which they are completing the valuation; the analyst will then apply a weighting to the characteristics based on company-specific data. To understand the potential impact of company-controllable factors on this weighting, we\u2019ve assigned them by level, split between high and medium impact:<\/span><\/p>\n

    Higher impact transaction characteristic levers<\/span><\/h2>\n