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 / Summer 2011 / Issue 63(originally published by Booz & Company)


The New Financial Matchmakers

Some leading PMNs include Angelsoft, IndieGoGo, and Kickstarter (early-stage funding); SecondMarket (the largest PMN, operating in several asset classes); SharesPost (later-stage pre-public stock); AxialMarket (lower mid-market M&A); Xpert Financial (growth capital); EquityNet (multi-stage equity); the New York Private Equity Network (private equity partnership interests); and Hedgebay and Lincoln Square Advisors (hedge fund investments).

Although still small by Wall Street standards, PMNs are growing quickly. For example, SecondMarket closed some US$10 billion in illiquid securities transactions in 2010, a fourfold increase from the prior year, including some $400 million in pre-public equities. At the same time, the number of ventures applying for funding through Angelsoft now exceeds 4,000 globally every month; companies listed for sale via AxialMarket have combined revenues approaching $50 billion; and the bid and ask listings on SharesPost already exceed $1 billion.

AxialMarket provides a good example of the genre. This network allows business owners and their representatives to offer their companies for sale to hundreds of institutional buyers, including public corporations looking for new technologies or products, and private equity firms with cash and management teams. When a company joins the network and provides its basic information, the system automatically generates a traditional “teaser” (a one- or two-page brief that outlines an investment opportunity without identifying the company) and then suggests particular acquirers based on the potential buyers’ previously registered preferences. The listing company can choose which of these should get the teaser, and the recipients that are interested in the opportunity can then execute online nondisclosure agreements to gain access to company  management and virtual diligence rooms. Both sides can manage and monitor the progress of the deal through the platform. Of course, eventually, humans do meet to negotiate and document the transaction; but the online discovery and initial evaluation processes are huge improvements over conventional practice in the mainstream capital markets.

Business leaders should welcome these developments. Aside from online brokerage accounts, the vast majority of “innovations” in the capital markets world during the past 30 years have centered on creating and packaging securities that distribute risk in narrow asset classes, such as home loans. Although these innovations have contributed mightily to Wall Street profits, they have done very little for new business formation, and have in fact done much harm. These days, the overall economy is awash in liquidity (bank reserves exceed $1 trillion, up from about $50 billion in mid-2008), but these dollars currently appear dedicated to purchasing and selling zero-risk Treasury assets, financing investments in higher-yielding foreign investments, and chasing hot commodities. Meanwhile, the Street’s creative energy has turned to computer systems that trade massive quantities of shares thousands of times per second to exploit microscopic arbitrages. New alternatives are needed, not just for the sake of the entrepreneurial economy, but for investors: Cash-generating businesses are, after all, more reliable inflation hedges than talismanic metals.

Some reasons that PMNs should prove very successful are obvious: Just as eHarmony allows would-be mates to find each other, perform a little due diligence, and establish an initial relationship, so too do PMNs allow companies and investors to locate each other and then efficiently narrow down the field of potential business partners. Today, 20 percent of all romantic relationships in the U.S. begin online, and there is little reason to suspect the corporate analogs will be less successful. And, of course, not only do private market networks perform introductions better than traditional intermediaries (because of their reach and speed), but they are also inherently less expensive, replacing humans and office space with nearly free network connections and servers.

More subtly, PMNs also perform the important function of disambiguating which fees are paid for what. For example, company owners normally pay big investment banking fees for basic knowledge of how the sales and money-raising processes work, access to the relevant institution’s relationship network, and the banker’s skill in structuring and negotiating the best possible deal. In a robust PMN, the first two elements are eliminated from the equation. As PMNs proliferate, investment bankers will be competing for fees based on more fundamentally valuable skills — those relating to creating the best possible deal structures and terms for their clients.

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