Bet on or Against the Unicorns

Addressing the illiquidity and inaccessibility of private company valuations, the concept of 'side bets' or swaps is proposed, enabling investors to gain synthetic exposure to unicorn performance without direct equity ownership. This mechanism, however, necessitates an agreed-upon, objective valuation metric for the private entity to facilitate settlement.

Analysis

The article outlines a conceptual framework for creating synthetic investment exposure to illiquid private market unicorns, such as SpaceX, through bilateral derivative contracts or 'side bets.' This approach directly addresses the inaccessibility for investors wanting to take either a long or short position in these highly sought-after companies. The proposed mechanism is a swap contract where settlement is based on the percentage change in a private company's valuation over a specified period, thus circumventing the need for direct equity ownership or share borrowing. The primary operational challenge and critical dependency for such an instrument is the establishment of a robust, mutually agreed-upon valuation metric to facilitate settlement, especially if the underlying company does not achieve a public market listing or a transparent funding round within the contract's tenor.

Key Decisions for Investors

• Investors should monitor the emergence of platforms offering derivative instruments on private companies, as these could unlock novel avenues for alpha generation and hedging in previously inaccessible markets.
• Extreme diligence is required on the settlement mechanics of any such 'side bet,' focusing specifically on how the private company's final valuation will be determined to mitigate significant basis risk.
• Consider that the development of such instruments could lead to enhanced price discovery for late-stage private assets, potentially influencing pre-IPO valuations and providing a new signal for market sentiment.