Blockchain Disruption in Finance: Private Equity

As highlighted in the previous articles of this five-part article series titled ‘Blockchain Disruption in Finance: Private Equity,’ it is only a matter of time until much of the financial industry will “run on the blockchain.” Or as the Harvard Business Review put it: “the blockchain will do to the financial system what the Internet did to media.”

The private equity industry will also not remain immune to blockchain disruption, much to the benefit of all key stakeholders involved in this sector.

What is Private Equity?

Private equity (PE) refers to an investment in the shares of a non-listed company. More specifically, private equity firms invest in companies that are either underperforming but can be turned around or in companies with a high growth potential. Companies can be either private or publicly-traded companies, which are then “taken private” through a buyout and a subsequent delisting.

Unlike hedge funds, private equity funds invest for the long-term. The investment period for PE funds varies depending on the firm’s approach and investment philosophy but has historically ranged from four to six years.

Venture capital (VC) is a subset of private equity and refers to investment firms that invest in startups and early stage SMEs, usually in high-growth sectors. In light of the early-stage of blockchain and cryptocurrency startups, it has been mainly venture capital funds who have invested in this space.

How Can the Blockchain Disrupt Private Equity?

Due to the blockchain ability to securely store and transfer in an immutable and transparent manner, it can help to reduce inefficiencies in recordkeeping, deal execution, and client onboarding while driving down operational costs.

Moreover, and perhaps most importantly, blockchain technology has the potential to democratize the private equity and venture capital space for investors as new funding models are now possible.

Recordkeeping

Stuart Lawson, Alternatives Global Product Manager at Northern Trust, said that one of the ways that PE fund managers can benefit from the blockchain is by storing all transaction records on the blockchain.

“All original fund records can be securely executed and stored on the blockchain and made available to all users who are ‘permissioned’ to use it. It creates a single version of the truth, which all participants can access and rely on, including advisers, auditors, and regulators. Transactions which involve multiple participants, such as a capital call, can be fully processed on the platform with all the requisite approvals, document delivery and movement of cash seamlessly processed with minimum intervention.”

In other words, all relevant documents can be digitized on stored on the blockchain while all stakeholders can transparently view all fund transfers and transactions.

Deal Execution

The execution window of a private equity deal can last up to several months from the point of sourcing the investment until the legal change of ownership. Investment teams can spend thousands of hours working on a deal while administrative, due diligence and legal fees can run into the millions. Furthermore, many of the systems that PE firms use are not interoperable, which slows down the process even further.

Through the implementation of a blockchain-based deal execution system, the workflow can become much more efficient and transparent for all stakeholders involved.

Access to New Clients

The investor base in the private equity space is largely composed of institutional investors. However, thanks to the blockchain, that will likely change as it will become easier to onboard new clients such as ultra-high-net-worth individuals (UHNWI).

Using a blockchain-based KYC/AML platform, the onboarding and management of new investors can be conducted in a much more efficient way than before as the signing of contracts, data sharing, and transaction management would become cheaper and faster than it is now.

A New Form of Fundraising

Perhaps, the most significant blockchain disruption in the private equity and venture capital industry to date has been Blockchain Capital’s token-based fundraising for its latest venture capital fund.

In April 2017, blockchain-focused venture capital company Blockchain Capital held a token sale to raise funds for a new fund. $10 million out of the $50 million fund were raised during the public token sale, which closed within only six hours.

The token sale was the first time that any investor in the world could hold a share in a venture capital fund through the purchase of the BCAP token. Furthermore, the BCAP token trades in the secondary market so investors can cash out on their venture capital investment at any time. Something that is not a possibility for investors in traditional venture capital funds.

Blockchain legal advisor Carol Van Cleef said: “ICOs [initial coin offerings] have the potential to impact significantly the traditional private equity markets, which historically have been relatively limited to insiders. ICOs are disruptive because they democratize private equity investing — more and different people are able to invest in deals they would not have had access to in the past.”

The blockchain has several disruptive qualities that the private equity industry can benefit from. The blockchain’s trademark features of being able to lower fees, improving operational efficiency and increase transparency will likely play a role in the private equity industry of tomorrow.

However, probably the most exciting aspect of blockchain technology for this sub-section of the financial industry is the new funding models that are made possible through digital token sales. It is unlikely that Blockchain Capital will remain the only private investment company that will raise money for a new fund using a token sale. This innovation completely democratizes the private equity/venture capital space as it allows anyone in the world with an Internet connection to become an investor in a PE or VC fund.

This is the fifth and final article in the five-article series Blockchain Disruption in Finance. I have covered (1) Securities Trading, Clearing, and Settlement, (2) Asset Management, (3) Securities Lending, (4) KYC/AML, and (5) Private Equity. I hope you have enjoyed the series. Feel free to contact me with comments and questions at jonas@perceptronventures.com. We are a small venture capital firm which builds ventures and invests in start-ups. We also provide advisory and consulting services. I am planning a new five-article series which will focus on how blockchain will impact governments and social good. Until then, keep “blockchaining”! Best, Jonas