May 1, 2017
Private transactions have since long been conducted directly between the transacting parties – for example, the investor and a private company. This process has largely been manual and cumbersome, and a large amount of diligence has had to occur in order for the parties to trust one another enough to undertake the deal. We’re seeing part of this transaction be made much more efficient by the transition to process trust.
There are different types of trust and therefore, diligence needs in a transaction, effectively at least: 1) the diligence on the actual investment merits, Ex.: Is the private company and its plan any good and 2) on the transaction itself – that by engaging in this transaction, can you trust that the execution, and if the paperwork and process itself is sound. Keep in mind that in private transactions, this latter type of trust has often been accomplished by referrals from private networks, robust agreements, and a long-winded process.
Compare this to exchange-traded products. How much time is spent evaluating if the transaction itself is robust? Arguably very little or none even. There exists a robust underlying trust in the process, which we can call process trust. With new online distribution models for securities deals as well as end-to-end investing and lending marketplaces, we can argue that this process trust is making its way into private transactions and changing the way we look at the actual deal-making. Due to the efficient nature of these marketplaces and the technological development, this shift may have a larger impact on how deals are put together than often thought today.
Data is also driving new possibilities given that the public disclosure of private information and private transactions is being marketed much more openly than earlier. This data that is now becoming public for the first time in private transactions makes available many new possibilities than before and will undoubtedly play a significant role in establishing trusted transaction value chains.
Take the notion of distributed technology (including blockchain) with its lack of a central trusted authority. Combine that with seamless digital user experiences, an airtight audit log, and reporting. It’s easy to understand why novel new models such as Angelist’s private syndicates gather millions or tens of millions of dollars in backing. There is a discussion to be had around deal merits (let alone signaling and herding mentality), which we can save for another time. But if you compare putting together all the paperwork from scratch, chasing signatures, personal details, doing countless in-person meetings, etc., it’s simply quite convenient when a systematic process can run through the entire chain of events.
As private transactions become more and more public, we will see a convergence of ‘private’ deals and ‘public’ deals. Process trust is one dimension that will get built out – with robust infrastructure – to exemplify process trust in private transactions. Over time, the fragmented market will gravitate toward best practices and uniformity, so all the checks in the book can be completed to a T.
In addition to standardization, the public market offers liquidity. Private transactions, by nature, often lack liquidity and lock their owners in for a long time, but secondary markets for private P2P loans, for private equity crowdfunding transactions and SME loans are being implemented to offset one of the core strains of the private market. Some regulatory environments are more favorable to secondary markets, for example, the Financial Conduct Authority (FCA) in the UK; some are more hesitant, often with existing mandates as barriers.
Process trust may indeed establish credibility to deals that have long been opaque and littered with information asymmetry. The extent to which this allows the asset class to blossom in the retail market remains to be seen, but one can argue that with a retail distribution becoming more and more mainstream, an underlying process trust must be established – otherwise, the transition will not achieve anywhere near a comparable level to efficiency as the public market.