What are Private Markets?

The year was 2010. Two visionaries with a handful of team members started a company in the heart of Chennai. They had a seemingly modest goal: revolutionising customer support.

With Accel’s seed funding in 2011, they hit the ground running, and in less than a decade, achieved the unicorn status. Come 2021, the company went public on the NASDAQ stock exchange with a billion-dollar IPO!

This humble startup is none other than Freshworks, who identified a gap in the market, took financing to solve that gap, and made a killing out of it (so did the investors).

Another company that sprouted its roots back in 2007, set out on a journey to create an e-commerce giant. Their platform gained momentum, and in 2010, they got a significant boost in seed funding.

We are talking about Flipkart, who in 2018, found itself in a fierce rivalry with Amazon, proving that even a David can challenge Goliath in the e-commerce arena! It goes without saying but Flipkart is a household e-commerce name today with a market cap of US$37.6 billion.

Let’s connect these remarkable success stories with the broader significance of private markets.

As of June 2022, the global private markets were sized at about US$11.7 trillion. To put this in perspective, India’s GDP in 2022 was US$3.5 trillion. The sheer magnitude of private market valuation shows the colossal impact they have on the global economy.

In this chapter, we will delve deeper into what private markets are, how they function, and their vital role in shaping the financial landscape.

Private markets are very similar to conventional stock markets — you invest in companies by buying and selling their shares. The main difference is the fact that these companies are not listed on any stock exchange. These shares are privately traded, hence the name “private markets”.

These markets are not restricted to just equity — you can invest in a variety of assets like private equity, private debt, venture capital, real estate, and other non-publicly traded securities. Any transaction you make, however, is handled manually.

Private markets help companies access capital, just like public markets do. It all depends on what stage the company is at.

Let’s consider a scenario.

Rahul has been working on a product idea with his friend for a couple of years, and he’s finally made a breakthrough. He decides to take a shot at developing it and forms a startup with his friend. For the first few months, their own savings are enough. They create an MVP and are able to acquire a few customers.

Then the workload starts to increase. Rahul realises they’ve got to scale up. And to do that, they need some capital. This is where private markets come in.

To raise capital for a startup, Rahul can go the equity way and approach investors in the venture capital space or the private equity space. In this case, he would offer them a stake in his company in exchange for funds. He can also go the debt route and head directly to a bank and take a business loan.

There are pros and cons to every method, of course. With the former, Rahul will have to sell a portion of his company. With the latter, he gets to retain ownership, but he will have to take on the added liability of the loan.

No matter what method of financing they choose, however, Rahul will have to complete the transaction by negotiating directly with the other involved party. There is no intermediary to standardise the deal.

As companies grow in size, they can go through several rounds of private fundraising. The valuation keeps increasing and so does the amount of funds raised.

In the first round of fundraising, founders will probably get a low valuation because their product is still in its fledgling stages. They could be raising US$1 million, for instance, at a valuation of US$10 million.

But as the company grows, the founders acquire more and more customers, and their product increases in value. By the fourth or fifth round of funding, they could be raising something in the range of US$50 million at a valuation of US$2 billion!

There will come a stage, however, when the amount the company wants to raise is too big for the private markets. It might be hard to raise that amount from a single investor or even a small group of investors. That is when companies consider the IPO route and go public.

Key Characteristics

Here’s how you can identify private markets easily.

Relatively Illiquid to Public Market

The stock markets are known for their high liquidity. You can buy and sell shares in seconds! With the settlement cycle being modified to T+1, the volume of transactions has increased even more.

Ironically, private markets are the exact opposite. Because it takes time to finalise each transaction, they attract just a fraction of the volume of transactions that public markets attract.

Investments in private assets cannot be bought or sold on public exchanges. Instead, once you’re invested, your capital is locked away at least for 3-5 years or maybe even longer. Planning out an exit strategy like a merger, IPO or maybe even a buyback can be quite a lengthy process.

T+1 certainly doesn’t apply here!

Limited Publicly Available Data

With public companies that are listed on a stock exchange, calculating the valuation is quite simple — you can directly obtain the market cap from the share price.

In the private space, however, calculating the valuation of a company can be quite complex. It gets even more complicated if the startup is pre-revenue! Because there are no publicly available market prices, we need to dig deeper.

Investors and fund managers use a variety of methods such as comparable company analysis, discounted cash flow models, and market multiples, to calculate valuation.

Flexible Regulatory Framework

While private markets are regulated by SEBI just like public markets are, they don’t involve intermediaries like stock exchanges. Private markets certainly enjoy greater flexibility, both for the companies and the investors.

Now, this has both pros and cons.

Because the deals can be customised, the company and the investor can work out an arrangement that works for both of them, even if it is not a standardised one. But, on the flip side, you’re forced to rely on the word of the other party. There is always the risk that they renege on honouring the terms of the contract later on.

Public v/s Private Markets

*Note: The minimum investment threshold of ₹ 1 crore mentioned in the above table pertains to Oister Global investors only.

When it comes to public markets, you can start investing with as low as a few hundred rupees. In private markets, however, the investment amount is much higher. Typically, investments can start from a few lakh rupees and go up to hundreds of crores.

There are mainly two types of investors who participate in private markets — high-net-worth individuals and institutional investors.

High-net-worth individuals (HNIs) are those who have liquid assets of more than US$1 million. These investors opt for a variety of asset classes ranging across the private and public markets to optimise their portfolio returns.

HNIs can invest in the private markets either directly as angel investors or through a VC/PE firm.

Institutional investors include all non-individual investors in the private markets. This includes institutions like pension funds, endowments, sovereign wealth funds, and insurance companies.

The process by which a company can launch its IPO is long, to say the least. It involves hiring an investment bank to underwrite the IPO and then the entire application to SEBI. Companies need to establish a certain track record before they can opt for this option.

But what about the companies that are just starting off? If IPOs are complicated and the public markets are hard to get into, then how can startups raise funds?

In our exploration of the Private Markets, we uncover these insights and much more.

If you think about it, private markets have been facilitating the growth of startups for decades now. Most retail investors only invest in companies that are listed on the stock exchange. However, before the companies reach that stage, the private markets are what nurture the fledgling startups and allow them to grow.

Without private markets, the world of investment would look very different indeed.