What is a private stock market?
At CartaX, we built something new: a stock market for trading private equity.1 We believe it will transform the way private companies approach ownership and capital raising, as well as offer early investors and employees meaningful liquidity from the companies they’ve helped build. To appreciate the transformative potential of a marketplace for private stock like CartaX, it’s necessary to understand how and why the U.S. equities market has evolved to make this innovation possible.
Defining a market
A market is a network that facilitates the pricing and exchange of an asset or service. We’re surrounded by markets: There’s the stock market, but also the bitcoin market, the real estate market, the market for engineers in Silicon Valley, and so forth. Some markets operate under well-defined rules and intentional market structure design, such as the market for Apple stock on the Nasdaq Stock Market, or the market for wholesale electricity on ISO New England’s marketplace. Other markets evolve in response to incentives of their participants, as in the market for elite law firm associates and in online dating networks in the U.S.
There is an important distinction between the market for a given asset, and a marketplace where the asset is exchanged. While the market is an abstract network, a marketplace is a discrete place or set of electronic interfaces where the exchange of assets or services takes place. One or more marketplaces may be small parts of larger markets. For example, Coinbase and Kraken are two marketplaces that are part of the bitcoin market.
The U.S. stock market includes several marketplaces where short-term traders and long-term investors come together to buy and sell securities, which represent equity ownership in an investment. Traditional marketplaces like the New York Stock Exchange and Nasdaq trade public equities, which include shares of company stock that any member of the public can buy, like shares of Netflix or Amazon. The public equities market is the one that people see monitored on their mobile devices and televisions. But there’s also a market for private equities, which includes shares of privately owned companies, like Carta or Stripe. Private companies do not have reporting requirements and are not listed on a stock exchange, so information about these companies, including earnings, business metrics, trading history, and current market capitalization (i.e., valuation), is not shared with anyone unless the company chooses to share it.
Exchanges vs. alternative trading systems
Financial markets have the good fortune of being well defined. The Securities and Exchange Commission (SEC) is an independent government agency that regulates the U.S. equities market. It provides rules and guidelines that define the market and govern its participants. Each marketplace then defines how it operates within those constraints and how its customers interact with each other to exchange securities. This framework protects investors and helps to maintain fair, orderly, and efficient markets, thus building trust, diversity, and, ultimately, liquidity.
In the Securities Exchange Act of 1934, the SEC defines a stock market with two straightforward criteria. An organization, association, or group of persons is considered to constitute, maintain, or provide a stock market, if it:
- brings together the orders for securities of multiple buyers and sellers; and
- uses established, non-discretionary methods (whether by providing a trading facility or by setting rules) under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of a trade.
Collecting order instructions to buy or sell securities, and then trading them according to a predefined priority and transaction framework that buyers and sellers agree to: Is it that simple to operate a stock market? Yes, and no. Stock markets also come in two principal forms, each with their own regulatory requirements: exchanges and ATS platforms.
Prior to 1998, if a marketplace met the above criteria, the SEC considered it an exchange, which meant it had to register with the SEC as an exchange and follow any applicable rules. This changed as a result of technological innovation: As the stock market became electronified in the ’90s, market operators started to provide trading facilities that met the above criteria, but were not registered as exchanges and did not provide the same level of disclosures and protections that are required of exchanges. In 1998, the SEC acknowledged that the market had evolved by establishing a new regulatory framework designed to “encourage market innovation, while ensuring basic investor protections,” called Regulation ATS. Regulation ATS opened the door to a second way for U.S. stock markets to register and operate, as an alternative trading system (ATS).
Stock market operators in the U.S. now have the option to perform the functions of an exchange, but to register with the SEC as an ATS instead of as an exchange. Currently, there are approximately 35 operating public equities ATS platforms, with another 54 that trade private equities, bonds, or alternative assets. In contrast, there are 16 stock exchanges.
Each regulatory framework has its advantages. The SEC gives ATS operators more flexibility to try innovative transaction and fee models, which allows them to respond to changing market conditions with greater velocity. Exchange operators must publish all changes for public comment prior to implementation; they’re also required to provide fair and equal access to all their products and services. In return, exchanges are entitled to collect a share of public market data revenues and have the regulatory authority to enforce their rules on their users.
Both exchange and ATS platform operators must be SEC-registered and each market operator must meet the regulatory requirements applicable to them. Each one defines the structure of its market by establishing the orders it will accept and the rules by which buyers and sellers interact with each other. Through this diversity within a common framework, the U.S. stock market for both public and private securities has developed the capability to adapt rapidly to the needs of market participants. BIDS’s conditional orders, Instinet’s market-on-close benchmark cross, Liquidnet’s negotiation platform, IEX’s speed bump, and IntelligentCross’s artificial intelligence trade optimization are just a few of the innovations ATS operators have introduced as they strive to improve execution quality, minimize signaling risk, and reduce fees for public equities investors.
Innovation and creativity are at the core of the U.S. stock market, which is the deepest, most liquid, and most efficient public equity market in the world. At Carta, we strive to push that kind of creativity forward while focusing on the needs of private companies and their investors. That’s why we decided to take the lead in creating an ATS platform for trading equity ownership in private companies: CartaX.
Why CartaX built a private stock market
CartaX allows select buyers and sellers to trade shares of private companies according to the tailored specifications of those companies. We designed the platform to offer private businesses a way to realize opportunities for liquidity without sacrificing the control and customization enjoyed in the private markets, and without the need for registering as a public company or listing on a public exchange. Founders and executives spend a great deal of time and effort structuring capital raises and tailoring secondary liquidity programs to meet their goals. Replicating this ability to offer customized secondary liquidity programs on a private, scalable, and secure platform was therefore one of our top priorities.
With public equities, marketplaces operate with a one-size-fits-all model for the companies that they trade. The same market structure, disclosure requirements, and shareholder visibility apply to all companies, whether they are an S&P 500 company that trades multiple times per second, or a less well known company that trades only a handful of times per day. Many companies, especially those with lower liquidity profiles, potentially suffer due to a lack of flexibility. Liquidity is spread across more than 50 marketplaces, so there is a visible lack of market depth for companies with low liquidity profiles. This means that it will likely be more expensive for an investor to transact in larger size for these securities, thus potentially perpetuating the lack of liquidity. Meanwhile, companies are still responsible for disseminating rather onerous quarterly disclosures and only receive quarterly information via 13F filings regarding institutional investors that bought or sold their stock.
This is why Carta decided to create a marketplace for trading equity ownership in private companies: We saw an opportunity to put founders, companies, and their leadership teams back at the center of the market by building a private stock market around them. Companies identify each buyer and seller eligible for their market, and set limits on how much stock each participant can buy or sell. The CartaX team created a disclosure framework designed to reduce cost and risk for the issuers of such equity without compromising the investor protections that disclosures provide. Only buyers and sellers approved by the company for their market are able to view company disclosures, place orders, or see pricing information. Finally, the private market aggregates supply and demand, and executes trades only within the range of prices approved by the company.
The CartaX marketplace offers privately held companies the opportunity to leverage liquidity solutions tailored to their unique needs and goals, while also right-sizing the disclosure obligations and providing transparency into and control over the network of institutional and other sophisticated investors buying and selling their stock. In this way, CartaX builds upon the innovations of the past three decades, to deliver a liquidity solution that addresses the needs of today’s private companies, their investors, and their employees.
If you have any questions, please contact Monica Simon, General Counsel, CCMX, at email@example.com.
1 Note that the term stock market is generally associated with a stock exchange. An ATS is not an exchange with regard to its registration and operation, however we use the term stock market to highlight the commonality in the structures of an ATS and an exchange. Both types of marketplaces fall within the definition of an exchange, and provide the same functionality (with regard to collecting orders, ranking them according to their respective priority framework, matching buyers and sellers, and trading in order of that priority), but for different types of participants and under different regulatory frameworks.
2 Fair access, public rule filing and comment, and public dissemination of quotes, to name a few.