Schwab forges ahead into private investments with Forge Global acquisition, but risks may outweigh benefits for clients and the RIA industry
Notoriously fraught private-share markets represent more downside -- and less upside -- than average investors imagine.
4 min read
Brooke's Note: The article I wrote on Nov. 12 about the Schwab acquisition of Forge Global was based largely upon a dialogue between Schwab CEO Rick Wurster and a handful of Wall Street analysts. I liked what I heard, and I wrote a “Brooke's Note” that reflected my positive take on Wurster's vision. Namely: Take a budding private shares platform that transacts shares from 625 companies for three million investors and radically increase the liquidity with Schwab's 46 million investors. What could possibly go wrong? But Jacob Miller, co-founder of Opto Investments, read about Forge with deeper knowledge and insight. (And, yes, he's arguably a competitor.) He concluded that the reader deserved certain caveats. In short, he says the private markets are perilous. In-the-know sellers sell shares to starry-eyed outsiders. The facilitating brokers – Forge, EquityZen Etc. – mostly just have incentives to see transactions completed. It's a recipe, he says, for … buyer beware.
Schwab's acquisition of Forge Global is an interesting step in the institutionalization of private markets and wealth, but not necessarily a step in the right direction for the industry.
The desire among investors to participate in pre-IPO names is real, so Schwab’s decision to partake, on its face, makes sense.
But compared with venture capital funds -- typically a diversified and professionally managed pool of capital – single, private, venture-backed company shares are far riskier.
Pricing these companies is hard in the best of times. These companies don't disclose much recent financial data, and the shares tend to be thinly traded.
Potentially, Schwab's institutional background and in-house expertise can help remove some of the inefficiency and opacity in the trading process.
And, you can hope that a Forge or EquityZen research department will bridge the informational gap. But these private-share secondary platforms introduce additional issues.
Transactional, non-fiduciary
Rick Wurster explains his first M&A deal in RIA terms and uses data points to bolster his case that Charles Schwab's 46 million client accounts can dominate private share markets
The platforms are transactional, and the firms are not playing a fiduciary role in selling their stocks.
Exacerbating matters, in most cases, employees or blocks of employees are providing the share supply by selling common shares. Employees will have much more information on the company than an external buyer.
Yes, employees at public companies sell all the time, but those companies have public disclosure to create a more level playing field. This informational asymmetry is not investor friendly.
Added to that, many top private companies have explicit transfer restrictions or right-of-first-refusal clauses, making the legal status of some of these transactions ambiguous.
Investing limits
The appeal of owning shares in known venture-backed names like OpenAI, SpaceX and Stripe is understandable. But many venture-backed companies fail.
Story Timeline
Also, venture-backed, pre-IPO companies turn public so much later in their growth cycle that much of the upside potential has already been realized and priced in.
Consider in 2019 that WeWork private shares were the most traded, with valuations of about $47 billion. It's nowhere near that now.
Unfortunately, regulation is such that accredited investors can buy these secondary shares of common equity directly. But they cannot just invest in high-quality VCs that have the team and background to price deals.
VCs can demand diligence and transparency into company performance and are usually receive preferred equity with better investor protections and rights.
Creating liquidity
It’s worth noting that Schwab's purchase price – roughly 70% below the implied market value at the time of the SPAC merger in 2022 -- implies that Forge still clearly faces material issues to make the secondary shares marketplace work and become a true source of access and liquidity.
Many employees prefer an existing solution to liquidity inside illiquid private firms – namely employers borrowing from legitimate lenders to create staff share liquidity.
One big advantage is that banks demand access to financial information to create a more thorough and orderly process of valuation.
Schwab’s extensive client base and corporate expertise help make closer to reality its vision of trading private shares like public markets.
The success of a platform like Forge seems more likely inside than outside Schwab’s walls, and getting in early with startup employees could prove to be a helpful new client source for Schwab’s core services
But the challenge is immense. Time will tell.
Jacob Miller is co-founder of Opto Investments, a private market investment platform based in San Francisco.
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