The Investment & The Trade
By Brandon Gadoci, May 29, 2014
When you buy a security in the public market there are two things that happen. First, you evaluate the investment opportunity and second you place the trade. For the majority of publicly available securities, the latter rarely affects the former. That is, trading is liquid and transparent with established terms that are agreed upon and generally unchanging. Commissions are set, delivery is T+3, and price reasonably presumed based on spreads. Efficient markets have addressed the friction of the trade and made it all but an after thought of an investment (usually adjusting cost basis).
Private market investing is different. Significant inefficiency and friction still exist in the trade and is cause for both frustration and opportunity.
The research we do at Disruption helps us to identify and evaluate potential investments. As a result, we know whether an investment opportunity is available prior to serious conversations with a founder. Our later stage meetings are about assessing the trade (or the deal as it is referred to in venture capital). While an investment opportunity may be available, we need to evaluate if we can get sufficient access to it. Research is about evaluating the investment opportunity and the trade is about positioning ourselves to participate in it.
Evaluating the deal isn’t about acquiring a large position in a company and it certainly isn’t about valuation squabbling. It’s about aligning interests and giving both the company and the investor the best chance to succeed. We consider things like preemptive rights, information rights, co-investors, and early-acquisition. Deal terms are an active topic of conversation/debate among innovation-economy participants and regardless of who has it right, there is consideration, and opportunity, in the trade.
The private market is maturing and as alpha and interest grow, attention is being focused on removing friction in the trade. Standardized term sheets and secondary markets are evidence of this. If we use the public market’s history as a guide, eventually (and inevitably) the trade will become less of a consideration. For now, smart investors will find opportunity in both.
In short, use research to inform you about whether or not something is a good investment. Consider the deal in determining if you should invest. Here is one example of how an investor is considering both the investment and the deal.