James McGillicuddy, head of strategy at Carta, on building an issuer-centric platform and investing in secondaries

Certainly. So CartaX is an alternative trading system that is the sole subscriber to Carta Capital Markets, which is a broker dealer.

The reason why I say that is because , to participate in the market, everyone, whether it's a high net worth individual who we're also targeting, institutional investors, if they want to transact, if they want to buy more of a company or actually just be net new buyer, they need to sign up with Carta Capital Markets, just like you would for any other brokerage account from Fidelity or T. Rowe or Schwab. That is the same here. So you sign up, you go through the KYC/AML, and then you're provisioned an account  for your firm to trade on.

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And is the focus mostly on large institutionals? Can you talk about what the makeup is looking like?

Certainly. So today, we have targeted primarily institutional investors. So think crossover funds, large asset managers, growth equity funds, late-stage venture funds, investors that want to transact on businesses that are -- it's called close to a billion dollars or greater of enterprise value.

We have not made a conscious effort to open the platform more broadly speaking to just high net worth individuals. And certainly not retail. We want to democratize access to alternative assets over time, but we want to first start with solving the pain point of these businesses today that want to move quickly, they want to provide liquidity for their employees and shareholders, and also having value added investors on the cap table.

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How should investors think about starting to participate on CartaX?  One of the things that we've talked about before was  larger firms creating CartaX trading desks. Can you talk a little bit about how firms are preparing to be involved in CartaX and how you think that might evolve?

Certainly. So there are some firms that we think over time will create CartaX trading desks like you look to. But then also it's pretty simple. It's like, it's sign up for brokerage account, start getting access to a subset of our 200 unicorns that are on the Carta platform and start interacting with the software, start buying and selling.

So it's a pretty easy onboarding process. And then the information and disclosures that you get -- that typically aren't associated with trading in the secondary market through the back alley brokers -- are completely available. And that's kind of a big part of the business is that it's not just a technology solution, it's quite a bit of legal innovation as well. And we wanted a go to platform that was issuer approved liquidity, but was also not distracting the issuer from increasing the enterprise value of the business and focusing on building, but at the same time wanting to make sure that the large, serious institutional investors had the right amount of information to transact.

So things that they need to know, like what's the fully diluted share count, what does the prep stack look like, who are the officers and directors , where's the cap position history of the business. All these small kind of things that, or details that, kind of seem like table stake, aren't provided by many of the traditional back alley brokers out there.

Therefore it's kind of the Wild West of secondaries still right now. That's why CartaX is bringing order to kind of this chaotic environment.

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And for institutionals to participate, obviously there needs to be block sizes that are large enough for them to be interested. Can you talk about the volume that's going to be traded in any single listing?

Yeah, so it's a really interesting point, Walter, and I think it's something that will shift over time. Is today, for most secondaries in the private markets, there has to be a minimum check size for some of these larger institutions, say 50 million bucks. What we think will happen is, is that the paradigm shift will change much like it did in the public markets where institutional investors can leg into and out of an account or out of a target.

We think the same thing will be true here. So our issuers are signing up for quarterly and even monthly liquidity offerings. So that means that if you're a large institution, you might buy only 25 million in the first auction, then you can buy 25 in the next and then 25  in the third auction.

And it doesn't have to be just one episodic slug of capital that you put to work.

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Yeah. I had a conversation with a broker about something about that. And one of the things that he said was that, if that's the model, then you need to get these large institutions' attention for some prolonged period of time, and one of the roles of the brokers is to sort of get the attention, and say, you know, if all the stuff that you're interested in investing in, like you should focus on this . Is there a role for the broker still in this model or is a big part of the thesis the disintermediation of brokers?

Today, anyone that participates on platform has to take principal risk. We are not having a model where folks can take an agency perspective and approach. So if a broker wants to onboard  their fund and they want to transact, then they should go ahead and do that. We do have secondary funds that are onboarding and doing that.

I'd say that the broker driven market, we think that a lot of the PMs are going to be making the decisions anyways. So we're providing them with all the information they need, the access to management or providing them with information and disclosures and supplemental disclosures that they need to make an informed decision.

So that's how we're going to market to begin with. And as the market evolves, I'm sure there'll be an opportunity for other players to come on the market, but today there's just so much demand for the issuers that we're listing and there's so much capital that's trying to onboard the platform that that's all we've had time to focus on.

You started off by saying  that CartaX is a bridge to going public. and a lot of the companies are unicorn companies. We had an interesting conversation with Alessandro, and one of the things he mentioned is that some of the companies that are actually closer to going public are probably already thinking  that they might just go public , and the pitches may be resonating with those who are a little bit earlier stage, maybe series C. Can you talk a little bit about the investor perspective on that and the types of companies that investors are most excited to see?

Certainly. Alessandro is definitely correct in his statement.

One thing I would add on there, though, is that all of these businesses are very, very different , and putting a blanket statement across all of them is  hard to do given that consumer businesses trade differently than enterprise businesses and hardware businesses.

So, he certainly right where there's a bunch of businesses that are just going to go public soon. And the IPO window is fairly robust and full right now. And as it should be, the Fed is just buying everything. We're totally cognizant of that. Al's totally right, though, that some of the businesses that are later stage, still have two, three years until they actually want to go public, are just very excited about onboarding to CartaX.

The onboarding to CartaX, too, it gives the issuer the control to move at their own pace to when they want to go public. The reason why Airbnb is going public isn't because they need access to capital, it's because they're getting pressure from employees and early investors for liquidity. That's that's the big reason.

Yeah, focusing on investors. Because you're on the front lines talking to investors every day, can you talk about a little bit what the CartaX pitch has been to them? That, and what aspects have been really resonating and what elements of push back you're getting.

Sure. So the CartaX pitch is kind of different for every investor from the sense of, are they net new investors? Are they previous existing investors in the business? Are they early stage? Are they late stage?  Where do they play in the ecosystem? Are they a secondary fund, for example?

Lind of the overwhelming pitch for all of them is that this is fair, efficient price discovery. And you actually want that as an investor. You want to be able to make sure that the business that you're working with or want to work with is coming in at a fair price.  If you're an early stage investor, you want to make sure that there's not some secondary individual or new firm jamming a new price on your CEO, and if you're a pre-IPO investor, you want to make sure that you're not overpaying for a given deal. So that's a big thing that's resonate with everyone is, hey, this is fair and efficient price discovery. 

The second thing that's resonating is the level of increased corporate governance. To the extent, the people know that a lot of these companies and the CEOs themselves love this aspect, that they just don't have to go from a non-reporting company to public reporting company overnight with analysts and everyone breathing down their throat.

So what kind of has resonated for everyone is like, hey, let's get on the glide path to go public. Let's start acting like we're a reporting company, and from there, the merits are kind of quite large, because then you're also getting to know the public market investors. You're starting to know the folks that are going to be putting not just 50, a hundred million dollars to work in your business as a private company, with two, three, four, 500 million plus over the course of your time as a public company.

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Yeah. On the flip side of that,  one of the things that I've heard from talking with investors who currently do secondary is that they do secondary in part  because it's opaque and that's where they get their alpha from. Can you talk about how you see existing secondary investors participating in this and how that might evolve over time?

Certainly. A couple of things there. One, totally understand for the folks that , the only way they can generate their alpha is through running around and trying to trade off information asymmetry. Definitely understand where this could be viewed as a potential threat. What I would say to them, though, is that the other way to view this is that, if you're building a relationship with these issuers, the companies that you want to be an investor in, and they're just not going to take, you know, they're not going to run a company allowed liquidity event because of the administrative overhead, this actually gives you an edge. Because this allows you to say, hey, listen, you're on the CartaX platform. All you do is you need to open up provision and auction. And then, you know me, you've liked what I've said about your business , and because the company is controlling who's allowed into the auction , they might be one of the few people that the company's allowed in. So we are giving issuers all of the control of the private markets with the liquidity in the public markets. So folks shouldn't really see it as a threat, and they should actually embrace it because now companies will be able to let them into their business in between primary rounds.

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That's interesting. One of the things that we've heard talking with secondary investors is, they obviously do some amount of primary so that they can get some access to information , and that allows them to get in when secondary opportunities become more available. Do you have a sense of how some of these kinds of tactics for secondary investors might evolve over time and what the role of the secondary fund might be?  So the sort of specialized secondary fund versus those more stage agnostic funds, how that's going to change over time.

Yeah, for the secondary investor funds , this is, I think, a great solution for them. It's literally giving them more exposure and more access to the best assets, versus them having to go bang down the door and get a meeting with the management team. 

Because many of these direct secondary funds, they don't trade, they don't buy and sell shares, unless they have the discretion of the company. For the funds -- the back alley brokers are kind of a different story.  And I mean, end of the day, I think you want to be doing things above board. I think you want to be doing things with the sanctioning of the business.

So we think this is gonna be a great platform, once again, that actually puts their business development efforts on steroids, and it's going to be getting all the companies that are okay with secondaries to adopt a secondary platform. And if they are a straight secondary fund, they're probably a RIA, so the venture exclusion rule of 20% doesn't apply to them.

Versus it applies  to venture funds that aren't an RIA, and only  20% of their fund can be put to work in secondaries. So it could be actually a really advantageous platform for the direct secondary funds, period.

Can you talk about -- I mean, this is painting with a broad brush -- but how investors should think about positioning themselves to be successful on CartaX for the longterm?

I think if you're a direct secondary fund and you want to position yourself or you're an investor to be successful in CartaX for the longterm. So one, you need to get a brokerage account to sign up for CartaX via the CCMX brokerage account. 

From there, it's being cognizant of how the auction works. It is different than traditional private markets investing completely and a little bit different than the traditional public markets trading. So just be aware of how the platform works. We're going to be offering training sessions, educational sessions, to make sure that folks understand how the platform works. 

And then three , participate. Enter bids, come to capital market stays, engage with the information that the issuers are putting out there. And those three things should put you in a really, really good position. I, my bet is that down the road there will be funds that are raised just for CartaX transactions. So that's another thing that we've heard and people have asked us quite a bit about, and there might be a couple of folks out there trying to do that.

So the ecosystem's coming, it's just a matter of time, but those are the three things to start where people can definitely make sure that they're in a position to win.

One of the things  that's interesting is this focus on building an issuer-centric platform. And you've talked about that a little bit, about how CartaX gives the issuer a lot of control. Is there a transition that will need to take place between issuer-centric regularly recurring liquidity events , and then eventually becoming sort of the New York Stock Exchange of the private markets where investors can turn around and sell to other investors on their own timeline? Is that part of the vision?  And is there a sense of what would need to take place to bridge the gap?

So the question around how do we create hyper liquidity I think is what you're getting at, of the change and the private markets. We believe that's kind of a function of the size, maturity in the business. And, oftentimes businesses shouldn't actually allow for hyper liquid stock, just from the size and stage that they're at. So kind of a loaded question.  The answer, I think, is somewhere in between what it looks like in the one-off secondaries market today and the hyper liquidity of the public markets.

But in theory, why does your stock need to trade as much as it does today in the public markets? Why is it that, for public companies, there's 33 trillion of secondary volume, but only 1.4 trillion of primary capital? Why do you need everyone continuing to churn those dollars?

I don't know if you do, so what does the solution look like? We have some ideas, but first we just have to make sure that we nail periodic auctions in the private markets of those first five, 10, 15 issuers that are really excited. And then from there provided that provides a tremendous amount of value, which we are certain it will, we can think about what the future looks like for somewhere in between.

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Makes sense. Can you talk a little bit about the auction mechanics -- how you guys came up with those mechanics, and what the investor reaction has been to that. Beause one thing about tender offers is that they're very simple and straightforward. Maybe they're too investment friendly in a sense, because there's no competitive price discovery or anything like that. But it does create for a much more, sort of  simple mechanics. Can you talk a little bit about that?

Sure. So I think there's definitely some thought that a tender offer from a pricing perspective is quite a bit easier. And it certainly makes sense, right. If you don't have to enter in a number of different bids into our system, and you say, hey, here's the price, take it or leave it.

Sure,  that is easier. It's certainly easier for employees too, but the crux of the problem is that it's not a fair and efficient market for them. So I'd say that, overall, reactions on the auction are that it's just different. It's like if you are asking an investor to drive a Model T and they're reaching for the reins. I'm teaching them how to drive the Model T and all these investors are super smart folks, so they should be able to figure out how to drive the Model T and if they keep on asking for the reins, then maybe they're not meant to ever drive the Model T, and that's a little bit of a paradigm shift that they'll have to undergo, but at the end of the day, it is what's best for the issuer and for the shareholders.

And therefore once they're a shareholder, but someone is purchasing their stock, it'll be better for them as well.

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That's interesting. I'm just thinking back about someone who is asked to drive a car after driving horses for awhile.

You like the analogy or no?

Yeah, no, I like it. I like it. Circling back to one of the things we talked about at the very beginning is, CartaX as a stepping stone towards going public, and one of the things I've heard about the longterm vision is that CartaX will eventually be a place where companies no longer have to go public. How do you think about the future of CartaX  and what the longterm vision is?

Yeah, well, I just want to be very, very upfront with, we didn't build CartaX so people never have to go public. I would hate for that to be the prevailing reason why people think that. We believe that it's , once again, a glide path for folks that want to go public, it helps them get up to speed on what disclosures are, get up to speed on corporate governance, et cetera, et cetera.

So once again, just want to dispel that we think it's just a platform, never go public, just use CartaX, stay private. That's not the world that we envisioned. But we do think that, for the companies that are living in that kind of a gray area between public and private, that this is the platform to make sure that they can provide liquidity to their shareholders while still aggressively investing in the business in a way that a private nonreporting companies allow you to do, which is not having to report to the street  and things of that nature, not having activist investors, not having short sellers, things of that nature.

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Yeah. This is kind of a weird one, but just something that came to mind. Obviously Carta's mission is to make more employees owners, and at the same time, liquidity often is about giving  employees an exit to their equity, although more properly framed it's about giving them the ability to diversify or balance out oftentimes highly concentrated wealth in a highly illiquid stock.  One of the interesting side trends that's been happening is employee SPVs,  employees going on the investor side and doubling down on their own position within a company. And I know that at Carta, there have been a number of employees that have spun up SPVs and wanted to concentrate even more of their net worth  into Carta. Can you talk about that? Are our employees participating on the buy side? Might there be that opportunity in the future?

Yeah. So a couple of things, I can't comment on the Carta cap table. I'm not privy to that. So I want to make sure that folks know that. And overall, I love this Dale Carnegie line where he says, most people say , don't put all your eggs in one basket, I believe you should put all your eggs in one basket and watch it very, very carefully. So my point there is that if employees of companies want to also be investors and double down, provided that they are in line with the legal and compliance frameworks that are laid out by the SEC around accreditation, then they should have that opportunity provided that their  management team, the CEO and CFO are okay with having employees as investors. So I don't think that that's a problem. That's a personal statement, more so than a CartaX endorsed position, just to be very clear there. We are not, at CartaX, like I said earlier in the interview, thinking about this as a kind of like broad retail access. Just because you're an accredited investor doesn't mean that we have the ability to onboard you and let you transact on CartaX today. Down the road, absolutely. It's just a prioritization of time right now.

And there's also some regulatory aspects. For example, you know, 12g states that you can only have 2000 non-employee shareholders in the cap table. So as you start opening it up more broadly to retail, you start running into issues around how large the cap table can get, and then once that's the case, you have to start reporting, which takes away the benefits of being a private company in many regards.

On that note, is there  anything that we didn't talk about that you might want to bring up to wrap this up?

Well, you know, I think one thing that's really worth noting is that  CartaX should bring a level of simplicity into the market. Meaning that right now, with secondaries, they're happening whether or not companies like it or not, and addressing that, and saying, hey, let's provide a platform that facilitates these so it takes the burden off the company and burden off the investors. So it really eliminates all the untidy cap tables that exist. It eliminates a lot of the burdensome overhead associated with roofers and it really eliminates a bunch of the information leaks it up and today.

Because an employee can now have the company disseminating the information about why someone should trade on their stock versus an employee saying, wow, I really need to pay off some student debt. So I'm going to sell a hundred grand in my position to this back alley broker. And I'm going to try and get them some information from the company so they can value it appropriately.

And then that back alley broker's going to turn around and spend, or is charged four or 5% on either side of the trade. So we think that there's actually a big, big reason why investors want  their companies on CartaX.

You mentioned this earlier, a big part of the thesis is LPs, other folks who do public and private,  some of these folks  may today invest directly, may invest in funds, venture funds, et cetera, and CartaX enables them to invest directly in some of these late stage companies. Can you talk about that dynamic a little bit  and potentially how that also might create conflicts between VCs and LPs and how you see that resolving itself?

Certainly. So the question's around some of the LPs that are traditionally investors in late stage funds, how is there gonna be a dynamic between basically them not maybe, I think what you're alluding to is, investing in the funds and just going direct. Well, I think there's a few points there. We're actually seeing a number of secondary funds that are springing up at the asset level managers. So they're actually springing up as a secondaries fund or direct fund where they co-invest alongside of their managers, or the manager says, hey, I actually have a really big position in Carta, let's say, and my $800 million fund, $700 million fund, whatever it might be, we can't put any more capital to work. So they'll actually basically allow their LPs, will give them access to it, because they trust and know those LPs.

So the overall thesis is that there's so much capital that needs to be put to work in these businesses, that a lot of these traditional funds managers aren't actually quadrupling the size of their funds because they want to stick with what they're good at. And they just want to move up the size of their fund appropriately to the point where they can still win deals.

The same reason why Benchmark Capital has never raised funds in excess, I think, of $421 million, because they know what they're good at and they stick to it. And as a result, they have some of the best returns in the industry.

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One of the things you mentioned about CartaX enables investors  to determine their own timelines in a sense, and not be beholden to this long duration that it takes to go public. Do you have a sense in talking to early stage investors, whether their mindset is shifting a little bit from, let's say, buy and hold, to buy and then trade a certain percentage at a certain multiple, and how they're seeing this change.

Certainly. A lot of early stage funds in later rounds are not opposed and are actually taking some chips off the table. So  if you own 15, 20% of a business and  you were the seed or a series A investor, the ability to actually return some capital to LPs, to mark your fund up a little bit, but then still let it ride, is super attractive.

The problem with that today  is that you can only do that at episodic events. The episodic events are typically a secondary into a primary.  If your portfolio has raised a big round, let's say a billion dollar round, and you didn't sell in to that primary, and four or five months later, you're now trying to offload a piece of that, the market kind of scratches their head and says, wait a second, you just raised at a billion dollars, why don't you sell into that primary? And so we actually think what will happen is, and we've done some math on this, is that for  a lot of these asset managers, all these early stage venture funds, they're actually going to increase the amount of proceeds that they would typically get from selling into that billion dollar round by selling in the quarterly auctions that happen post that billion dollar round.

So maybe they sell 50% into that billion dollar round and then the rest of their 50% over the next four auctions. And that ends up increasing their total return in between the billion dollar round and the billion $5 rounds by 1.25. So it's actually great portfolio management as well.

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Do you see a lot of these investors having to develop more sophisticated portfolio management strategies and programmatic trading to fit a world of programmatic liquidity?

I don't think it's going to be sophisticated in the sense that the public markets are.  If by sophisticated, you mean that they might have to do some math in an Excel spreadsheet to figure out, hey, between this round and the next round, we think that every quarter, the price will increase by 25%, and we should sell off 15% now, 20% now, then yes. Now either remember too that a lot of these investors are doing that for their public positions too. Not all of them sell immediately when a company goes public. They have different price targets that look to, that once they hit these price targets, it might map to how the fund's performing overall. Or maybe they just have one winner in that fund. And they might actually make the price gets higher so they can raise their next big fund. So I don't think there'll be super sophisticated, crazy public markets type of stuff, but it will be just basic portfolio theory.

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