Private capital’s tokenised future

With companies staying private for longer, retail investors have even more to gain from early exposure. Tokenisation could help broaden private markets access, offering greater flexibility than what is currently on offer.

During a period of record-breaking IPOs, retail investors have been keen to cash in. June’s SpaceX listing saw 20% of shares allocated to these investors, who collectively spent an estimated $15bn.

Shares in SpaceX have since risen about 10% from their original offer price of $135, providing some meaningful paper gains so far. The real prize, though, went to those investors who had access long before the IPO.

Peter Thiel’s Founders Fund invested $20m in 2008, with a further $600m in follow-on investments. Forbes put the value of the firm’s stake at $67bn as of the opening trading price of $150, a multiple of 108x on invested capital. A more recent backer was Sequoia Capital, which reportedly achieved a 14.5x gain after first investing back in 2019.

OpenAI and Anthropic will likely tell similar stories when they make their debuts. While substantial gains can be made on the public markets, the most significant growth of these companies comes when they are privately held. That’s even more the case now, with companies staying private for longer.

For retail investors to capture that growth, they need to participate at an earlier stage. Open-ended funds have gone some way to facilitate this, but they are typically reserved for wealth investors. These vehicles often carry strict eligibility requirements, while practical constraints mean they have large minimum investments.

Tokenisation could be the alternative. Here, fund interests are represented using a digital token, recorded on a blockchain. By automating the investor register and distribution process, GPs would avoid some of the logistical challenges associated with facilitating smaller commitments.

The technology “allows you to take a fund interest and divide it into much smaller units”, explains Dr Steffen Pauls, CEO of private equity investing platform Moonfare.

“One very large commitment can be split into tokens, which can be fractionalised further. That’s how it can help bring minimum investment sizes down,” he explains.

The same could be said for ownership of the private assets themselves. Tokens could represent a stake, allowing private companies to have a much more fractionalised investor base, similar to what is seen on the public markets.

First steps

There are already some examples of this technology at work. In June, Citi began offering its private wealth clients access to tokenised depositary receipts representing shares in blockchain platform Kaleido.

The measures don’t quite amount to the full tokenisation of shares in a company, but they are a significant step in that direction. Citi’s receipts function as a separate security issued by the bank. This is distinct from owning the shares directly, and does not give the owner the rights of a traditional shareholder.

On the fund side, Hamilton Lane launched a new tokenised share class in May, providing access to its evergreen Global Private Assets Fund. The firm has made the product available through digital marketplace Allfunds. BBVA Asset Management is the first investor, with an initial period of exclusive distribution for institutional portfolios, but not yet for individuals.

In 2023 the firm also provided access to its Equity Opportunities Fund V through a feeder fund managed by fintech company Securitize.

While fund tokens could help reduce minimum investment sizes, they still represent the same security, and are subject to the same regulations. Depending on the jurisdiction, they could limit access to wealth investors. Hamilton Lane’s feeder fund restricted access to qualified purchasers with at least $5m in invested assets.

In the UK, Michael Sholem, a financial services regulation partner at Macfarlanes, says that “The FCA has been consistent in stating that a significant amount of fund tokenisation can already be achieved within the existing regulatory framework, provided the token represents an interest in a fund that is itself operated in accordance with existing UK regulated funds regulation.”

This means tokenisation could operate within fund structures such as LTAFs, which do not impose minimum investment sizes and provide access for ordinary retail investors under the category of “restricted investors”, limiting them to investing no more than 10% of their net assets in the vehicles.

Managers will typically still set minimum investment sizes themselves, to meet onboarding costs, which tokenisation could help drive down.

Retail access to tokenised stakes in private assets would also face regulatory hurdles, depending on the rules governing how these securities are offered. The highly fractionalised ownership that tokenised stakes could create would also have problems of its own.

“Private companies are not generally designed to accommodate potentially thousands of very small investors each exercising individual voting and information rights,” says Sholem.

“For that reason, many tokenised models are likely to use some form of aggregation mechanism.” This could involve investors holding tokenised interests through a nominee, special purpose vehicle or other intermediate structure, with voting rights exercised collectively.

The owners of these tokens wouldn’t exercise governance rights themselves, in the same way that Citi’s private wealth clients don’t have direct governance rights at Kaleido.

The case for going public

If mass tokenised ownership was successfully rolled out, it could mean there are limited incentives to list.

The transparency and reporting requirements that come with being a public company have historically been seen as a necessary trade-off for additional fundraising capabilities. If private companies can also tap into this capital, why would you want to go public?

Pauls thinks there are still good reasons: “Listing gives you a very deep pool of institutional capital, index inclusion and a quoted currency for acquisitions. You also get price discovery from a large number of informed buyers and sellers. A tokenised market with a modest number of participants wouldn’t replicate that.”

The reporting requirements of the public markets are a cost, Pauls says, “but it’s also what gives investors’ confidence in the valuation”.

Private markets valuations, by contrast, are drawing increasing scepticism, with listed private capital vehicles frequently trading below their net asset value.

And while tokenisation can provide additional liquidity, it would be limited by the scale of the market. There may not be enough buyers and sellers to replicate the opportunities that exist elsewhere.

“Even if the technology allows for continuous trading, there is a real question as to whether a meaningful secondary market develops,” Pauls says.

It’s easy to see how real-time private markets transactions could occur for stock in Anthropic and OpenAI, given the scale of demand, less so for the mid-market investments that are often favourites of the private-equity industry.

And tokenisation would need to compete with the existing liquid vehicles that invest in private markets, which are already offering exposure to high-growth businesses.

Baillie Gifford US Growth Trust, a publicly traded vehicle run by the investment manager, had spent £5.9m on the SpaceX holding it had at the IPO, a position it started building in 2018 that ultimately delivered a 27.7x multiple.

What tokenisation would offer here is much greater choice, allowing investors to look beyond these listed vehicles to other funds and companies, where regulation permits.

Providing that access could help spread the benefits of soaring tech valuations more evenly, at a much earlier stage. If the tech industry wants to win over the public, tokenised access might be where it starts.