Key Takeaways
- Secondary investing in private tech targets illiquid markets, offering unique opportunities for value.
- Second Alpha leverages data, AI, and a 50-attribute model to identify private tech investment targets.
- Securing shareholder waivers and managing rights of refusal are critical for secondary deal execution.
- The $165 billion secondary market for private tech requires expertise in sourcing and valuation.
- AI's impact on private companies includes lower marginal costs and significant labor market disruption.
Deep Dive
- Richard Brekka's upbringing exposed him to entrepreneurship via his CFO father at Continental Airlines and successful friends' parents.
- He realized success often stems from a great idea and hard work, exemplified by the creation of "The Karate Kid."
- Brekka helped build Nextel into a nationwide cellular business by acquiring spectrum.
- He took Nextel public after its success at Chase.
- He then moved to CIBC to establish a private equity group in New York, which saw four successful years.
- Brekka took over Gomez Inc., a dot-com company that pivoted to website monitoring after the internet bubble burst, becoming chairman and CEO.
- He implemented a crucial cash flow strategy by switching from monthly to quarterly billing in advance, improving financial stability.
- Gomez Inc. was ultimately acquired by Dynatrace, with its core product forming the basis of Dynatrace's current offerings.
- A Bank of America analyst's call about Gomez stock certificates revealed the potential of the secondary market.
- A secondary investment in Gomez yielded the same multiple as the nine-year primary investment in just six months.
- This significant success prompted Richard Brekka and Jim Sanger to found Second Alpha, focusing on secondary investments.
- The secondary market distinguishes between LP interests in funds, GP-led continuation funds, and a trading market for funds.
- Second Alpha specializes in the secondary direct market, buying shares of private tech companies from existing shareholders.
- The secondary market is projected to reach $180 billion in 2024, with top companies like OpenAI and SpaceX dominating the upper end.
- Second Alpha maintains large databases of U.S. and Canadian private tech companies, tracking their development and financing status.
- Since 2015, they've collected data from S1 filings for U.S. tech companies considering an IPO, including three years of financials.
- A 50-attribute model is used to pattern-match S1 filings with their private database, narrowing potential investments to 200 companies.
- The firm contacts CEOs to understand business function, exit timelines (3-5 years), and shareholder base diversity.
- Second Alpha identifies shareholders needing liquidity, often smaller stakeholders overlooked by the CEO.
- Securing waivers for the company's right of first refusal (ROFR) and similar waivers from investors is crucial to avoid wasted effort.
- They often obtain a majority waiver (50.1%) from investors by approaching key individuals like board members.
- Sellers often divest shares due to life events, and securing one seller can lead to others following suit, allowing for aggregation into larger positions.
- Second Alpha's current $170 million fund aims for 20 companies, ensuring no single company exceeds 10% of the fund.
- Early discussions with CEOs about exit plans are critical, and proactively building relationships with strategic buyers two years before an M&A process facilitates smoother exits.
- For an IPO, a company needs predictable earnings for at least the first year post-IPO, requiring deep business understanding.
- Prove Identity, a key portfolio company, expanded from verifying individuals for banks to validating drivers/passengers for Uber and Lyft, demonstrating significant growth.
- Direct individual 401(k) investment in private tech companies is considered unwise, with large money managers being a safer approach.
- Private market valuations are benchmarked against public comparables; the firm historically paid 2.5 times revenue.
- The recent market correction followed unsustainable 15-20 times revenue valuations observed in 2021.
- Artificial intelligence (AI) is a significant development, lowering marginal costs by substituting for expensive skills and potentially causing labor market disruption.