How periodic auctions can protect less-sophisticated investors

Knowledge Base
Thursday, October 05, 2023

Public markets have historically been dominated by experienced, sophisticated investors, armed with extensive information and analytical tools. The private market is a different beast entirely. While there are, of course, highly sophisticated private investors, there is also a large portion of private shareholders with considerably less expertise. Many of these individuals have become shareholders without understanding the true value of the equity they hold and the routes they have to liquidity. This is only increasing with company equity becoming more prevalent, the rise of crowdfunding, fandom equity and the simple fact that companies are staying private for longer. 

Due to the way that the trading of private shares has historically been carried out, when a liquidity event does occur, less sophisticated investors can often struggle to get a fair price for them. We sat down with Asset Match co-founder Iain Baillie to talk about how periodic auctions on a platform with a pricing algorithm can protect less sophisticated investors. 

What do you mean by ‘unsophisticated’ or ‘less sophisticated’ investors? 

Although the term 'unsophisticated investor' might sound a bit harsh, it's not meant to be derogatory. It simply refers to individuals who may not have been involved in many liquidity events. These are often people who invest in companies they have a personal affinity to like the BrewDog shareholders that use our platform and have equity either because they just love the brand and and likely purchased a small bit of equity via its Equity for Punks crowdfunding campaign, or the Tottenham Hotspur fans that purchased shares to feel more connected to the club. 

They're not necessarily looking at balance sheets or market trends; they're guided more by passion or personal interest.

Employee shareholders tend to fall into this category too. It’s increasingly common for companies to offer their staff equity as part of their pay packet. The problem there is that often those employees have little to no idea how those shares work or how much they’re worth. 

The final group we tend to deal with is friends and family investors. As we’ve said before, when the WhatsApp founders raised $250,000 from five of their friends, that’s not the usual friends and family round. Their investors were ex-Yahoo, seasoned tech-heads who had been on the front line of the dot-com bubble. Often they’re investing to support someone they know, not necessarily for financial gain, which can lead to tension further down the road. 

In the past, how would these investors go about cashing in their shares?

Before platforms like Asset Match, if it happened at all, the process was cumbersome and opaque. Essentially, the board of directors would set a price, often arbitrarily. Shareholders wanting to sell had to notify the company secretary, and there were often restrictive pre-emption rights that made selling difficult. It was a process shrouded in darkness and inefficiency.

And how were those shares priced?

The pricing was often done by the board, sometimes with the help of accountants, but more often than not there was very little financial modelling. They'd use very simplistic methods like discounted cash flows or multiples of revenues or profits based on gut feel of wider market sentiment. It was more of a 'finger in the air' approach than a transparent, market-driven one.

How does the trading and pricing of private shares differ to pricing on public markets? 

In public markets, pricing is dynamic and driven by a multitude of factors, which all ultimately affect supply and demand. One announcement or mistake or huge trade can have a big bearing on the price. 

In contrast, private markets have traditionally been less transparent, with pricing often determined by the board or a founder, rather than market factors. The fact that the investor base is also more diverse, with many who are less informed, means there’s often an information imbalance, leaving less sophisticated investors in the dark. Further to this, due to the limited equity they own, these investors are often overlooked and must settle for the price they’re given. 

One of the biggest advantages of public markets is liquidity. You can buy or sell shares instantly during market hours. This is particularly beneficial for investors who may need to cash out their investments quickly. 

In private markets, the opposite is true and liquidity is often a significant issue. Traditionally, if you wanted to sell your shares, you'd have to go through a cumbersome process, sometimes needing approval from the board or other shareholders. Platforms like Asset Match aim to solve this problem by providing periodic liquidity events.

How does Asset Match differ from traditional private market trading?

Asset Match brings transparency and fairness to the private market. We use periodic auctions to determine the price of shares. For example, in our first BrewDog auction, we had orders ranging from £25 to £215 per share. The auction algorithm found a fair price at £125, and everyone who wanted to sell at or below that price got £125. It's a democratic process that levels the playing field.

Without that initial price discovery process, those willing to sell their shares for £25 would have ended up selling their shares at a considerable discount. More sophisticated investors, whether through experience or access to more information, would have been able to take advantage of that lack of knowledge.  Our pricing algorithm arrives at a price where the most shares change hands, ensuring a fair and logical price for transactions. Everyone deals at that price, which acts as a great equaliser. This protects both the less sophisticated and the less informed. We also encourage companies to share as much information as possible and to hold auctions when maximum information is available, like just after audited accounts are released.

Want to know more about cashing in your shares? Read our Q&A on Triggering a Liquidity Event