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10 Tips for Building a Strong Relationship with a Broker
Building a solid relationship with a broker can be valuable when trying to navigate the illiquid, volatile, and complex private secondary market. Here are ten tips to help build a positive and productive relationship with your broker.
Demand Honesty. Brokers who intentionally lie to clients are unlikely to retain their licenses, but vague or unusual statements should be a red flag. There are many ways to misrepresent a situation without technically lying, so look for clarity and consistency, and learn to distinguish “enthusiasm” from misrepresentation.
Seek Transparency. If a broker says, “My buyer has access to cash,” this may mean that they represent a syndicate who might successfully raise capital. Better: “Buyer has provided proof of funds and can wire cash within 72 hours of signing the SPA.”
Don’t Bid Against Yourself: While all of our engagements are non-exclusive, keep in mind that if you present your offer or bid to a half dozen brokers or platforms, these ultimately end up in the inbox of buyers or sellers (a relatively small universe), creating the illusion of more supply or demand than actually exists. This can lead to a spiraling price in the direction opposite to your own interests.
Avoid Soothsayers: Be cautious of brokers who make predictions about market trends. Your broker’s role is to facilitate transactions, not predict the future. Rely on research reports and data-driven insights for decision-making. For instance, I provide a snapshot of firm bids, asks and recent crossed trades.
Keep Organized: There are more than 20 steps required to complete the average secondary transaction. Ask your broker how they manage and track them. I use a customized “Trade Roadmap” that allows all parties to know which step is next in the process, who is responsible, and the status of tasks required to complete the trade.
Eschew Haste. When a broker rushes you, beware. It may be in their interest to close quickly (or the manager of an unfunded SPV who is trying to raise capital), but not in yours. Of course, after a trade is matched and the transfer process has begun, prompt responses are expected and appreciated.
Value Experience: Each company has a unique set of bylaws and processes in place to manage secondary transactions (some block them entirely). Whenever possible, work with brokers who have successfully completed transactions with the company.
Stay Compliant: US brokers are required by various laws to conduct KYC/AML to detect potential fraudulent activity. Be sure your broker, even if non-US based, can ensure the counter-party you are introduced to is who they say they are and has the shares or funds they claim to have.
Be Realistic: The private secondary market may be illiquid, but exceptional deals are rare. Multiple platforms now give a reasonable estimate of a private security’s price, so if your broker brings you something that is significantly above or below that, the chances are high that the trade will not close. Sellers should keep in mind that their shares could actually be worth nothing, and that buyers are looking at worst case scenarios when valuing private firms.
Honor Your Word: Abide by your written commitments, including those made via email. Failing to do so will likely get you placed on a list of unreliable partners by the company, the counterparty, and the brokerage firm. This will negatively impact your ability to trade in the future.
BONUS TIP - Stay Humane:
In a volatile market, where sellers’ decisions impact their livelihoods and buyers face substantial risks, stress is normal but try to stay courteous. I don’t work with clients who are unprofessional, angry, or demeaning. Start a transaction with a smile and end with a thank you: Even if it doesn’t directly impact your bottom line, it will profit you in the long term.
2022 Recap & Five Pre-IPO Lessons
By Chad Gracia
A great deal has happened since my last year-end note. I moved my office from Kyiv to Lisbon, where I will remain until it’s safe to return. War, inflation, high profile bankruptcies, and a general market decline have made buyers more cautious and sellers more willing to sell their shares. Here are the five lessons I’ve learned this year and which may be helpful for those interested in investing in the private secondary market:
1. Private companies are blocking direct transactions more than ever. This has two implications. First, many buyers will find that SpaceX, Carta and dozens of others can only be acquired via SPVs. My advice is to find funds that do not charge annual fees or carry. Second, in many cases companies can selectively block transfers, so it’s important to choose your counter-party wisely. An ex-employee who left on bad terms is more likely to get blocked than a high-performing current employee doing the transaction for “household purposes.” Finding a seller with the best chance of closing a deal is an essential part of my job as a broker.
2. Common shareholders (generally employees and ex-employees) are in many cases offering shares at between 25% - 75% less than institutional holders of preferred shares. For investors who have confidence in a company’s future and can tolerate this “preference risk,” acquiring smaller lots of common shares to reach a target allocation can lead to a significantly lower average cost basis.
3. As I write every year, buying a security in the months before an IPO is very often an unwise strategy, since most of the upside is priced in (and then some). We at Rainmaker have consistently focused on companies where an IPO could be expected in 18 to 24 months (slightly longer now considering market conditions), as we believe this provides the optimum entry point on the “J Curve” (see page 26 in our latest deck). Keep this in mind if and when the IPO market heats back up.
4. Transparency, integrity, and professionalism are priceless. Our market is a relatively small and close knit community of brokers, buyers, sellers, boards, law firms and CFOs. Price fishing, misrepresenting relationships or ownership, falling down on trades, or having a hostile attitude will eventually make it harder for you to transact at all. The converse is also true: Clients who are respectful and sincere about their goals are those that generally get a “first look” at trades and inspire brokers like me to put in the extra effort to help them achieve their goals.
5. The private secondary market, like the world at large, is a risky place. Never invest more than you could comfortably loose, and remember to treasure and cultivate the people in your life as much as your portfolio. In that way, we can all look forward to a rewarding 2023, no matter what happens in the market.
We continue to actively cover over 100 late stage private secondary companies, and I’m happy to share information on the market, pricing, or research. We also just released our research report on the defense tech company, Anduril, which is available to accredited investors.
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2021: Top Ten Mistakes Investors Make in the Pre-IPO Secondary Market
By Chad Gracia
After several years following hundreds of trades representing billions of dollars in the late-stage pre-IPO secondary market, I’ve seen firsthand the mistakes that sink deals and which successful buyers and sellers avoid. I’m sharing them today to help you achieve your investing goals in 2021. (These are my personal experiences and opinions, and as always, accredited investors should consult their advisors and/or legal counsel before making any investment decisions. This is especially true in the highly volatile and risky pre-IPO market.)
Not only do these mistakes cost money, but they steal away your most precious resources: time and reputation.
WAITING UNTIL AN IPO ANNOUNCEMENT TO BUY -- Rainmaker Securities focuses on private companies where an IPO or exit is possible within 6 to 18 months. Lately, when a private company announces plans to go public, prices skyrocket as buyers from around the world flood the market with orders. Meanwhile, sellers either pull their shares or demand significant premiums. We’ve seen companies double in price in the hours after an IPO announcement or even a rumor of one. To make matters worse, companies generally do all they can to “lock in” the cap table and forbid direct transfers, leaving only SPVs or forward contracts as a means to access shares; both have their drawbacks. In some rare cases it might make sense to buy after an announcement, but generally this approach is more expensive, time consuming, and carries more transaction risk than simply buying on the public market after the IPO.
EXPECTING FINANCIAL DATA OR OTHER INFORMATION -- If you need more information than can be found in Pitchbook, Crunchbase, and / or Google News, it’s probably better to wait for the IPO. Employee sellers are generally prevented from sharing information by NDAs and institutional sellers rarely have the ability to share any financial information. Of course, one of the advantages of remaining private is that these pre-IPO firms generally share information with only a select group of primary round investors. Due diligence can be done by looking at the macro environment, the track record of previous primary round investors, and other public data. Even asking for financial data raises red flags as to whether this risky private market is right for you. In short, public companies may offer a more appropriate investment for those investors requiring financial data or other non-public information.
MISUNDERSTANDING COMMISSIONS -- Brokerage commissions are ubiquitous, fairly standard, and negotiable based on ticket size. Very often sellers will come to us with a strict line in the sand: “We don’t pay commissions.” This approach is both meaningless and potentially counter-productive. First, since the commission is built into the price, it is in effect always paid by both parties equally. Even if a seller doesn’t manually wire a commission at the end of the transaction, the amount is deducted from the cash they receive upon sale. The only savings is a wire transfer fee. Second, by refusing to be the “engaged party,” this forces brokers to engage with the counterparty, and thus in some sense to work against the seller’s interests. If I’m engaged and work on behalf of a seller, I do my best to get the highest price; if I’m engaged with a buyer I work to get the lowest price. (Of course, often the market itself sets the price with no room for negotiation.) In effect, a seller may avoid paying a wire fee and save a few minutes electronically signing a non-exclusive agreement, but there is potentially a significant cost to this approach.
ATTEMPTING TO ‘GAME’ THE SYSTEM -- The pre-IPO market is a relatively small and tight-knit community, and violating the trust and time of those you work with (brokers, buyers, sellers, companies, legal firms, etc.) can have long-term negative impacts on your ability to transact in the future. While we may compete for business, we do share information about unreliable clients or “bad actors.” So if you suddenly find that no one offers you deals or wants to work with you, it could be because you’ve committed one of the following borderline unethical behaviors I’ve seen this year:
MISREPRESENTING YOURSELF -- A buyer claims to be buying shares, but at some point in the transaction, it becomes clear they are an intermediary (broker, advisor, etc.) of the real buyer. Broker-Dealers have contracts that allow them to work with intermediaries, but morphing from a buyer to a broker mid-transaction can be career-killing. On the other side of the ledger, we’ve seen entities posing as “sellers” of shares, when in actuality they are collecting cash which they will then use to try to purchase shares on the secondary market, usually unsuccessfully. Brokers identify these imposters almost immediately and make it a point not to work with them again.
RE-NEGOTIATING A TRADE AFTER AN INTRODUCTION -- Our job as brokers is to find firm matches in terms of price, structure, size, etc. before we introduce buyer and seller. Of course, either party can change their mind before signing an STA (Share Transfer Agreement), but agreeing on terms with the sole intent of re-negotiating directly with the counter-party after an introduction is an excellent way to achieve persona non grata status in the pre-IPO secondary community.
OFFERING SHARES YOU HAVE NO RIGHT TO SELL -- A broker can spend many hours onboarding a new client and performing FINRA, SEC & Patriot Act required compliance: KYC (“Know Your Client”) and AML (Anti-Money Laundering), so it’s extremely disappointing to find out after this expenditure of time and energy (from the broker, compliance department, and other support staff), that your shares have transfer restrictions, you can’t sell due to lack of spousal consent, tax issues or other obstacles. Before engaging a broker, be sure you have the legal right to sell your shares.
“BUYING” WITH SOMEONE’S ELSE’S HOPED-FOR MONEY -- It’s fine for a VC fund to line up LPs to invest in an entity that will in turn invest in the pre-IPO market, but be sure these funds are secured before engaging a broker and certainly before the introduction to a seller. Nothing is worse than coming to an agreement on a transaction only to discover that the funds are not available to complete it. Word of such actions spreads quickly and is not soon forgotten.
WORKING WITH MULTIPLE INTERMEDIARIES -- The number one deal-killer I’ve seen this year can be traced to a simple mistake: trying to transact when there are multiple intermediaries. Ideally, the buyer and seller should each have a single broker in direct contact with the decision-making counter-party. For each additional intermediary (co-brokers, inter-brokers, foreign finders, informal advisors, etc.) the potential for miscommunication rises exponentially, as does the risk that the transaction will fail.
DISRESPECTING YOUR COUNTER-PARTIES -- Honesty, courteousness, and timely responses are not only essential to getting a deal done, but they show you have a respect for the needs of the many individuals working behind the scenes to help you achieve your investing goals. Keep in mind that the average transaction relies on the work of around a dozen people (seller’s team, buyer’s team, brokers, compliance, operations, accounting, legal teams, IR and outside advisors of the company itself, and more) and can consist of 20+ steps. Your broker should be a guide and handle as much of the logistics as possible, but timely, straightforward and courteous communication will not only make everyone’s life more pleasant, but it will mark you as someone worth doing business with and bringing deals to in the future.
And in the long-run, that’s one of the most essential qualities to being a successful investor in the Pre-IPO secondary market.
If you disagree with my top ten mistakes or have more insights to share, please let me know.
Chad Gracia
Registered Representative, Rainmaker Securities