Private Markets vs Public Markets: Five Structural Gaps

On five questions the two sides answer differently. Price: a figure somebody is currently willing to deal at, against a figure produced by judgement on a timetable. Access: an order against an invitation and a signed promise. Exit: a sale against a negotiation. Information: publication against a contract term. Cost: a stated charge against the gap between two multiples on one fund on one day.

Almost every argument about this subject goes wrong in its first sentence, so begin with the word itself. The word private does not name a kind of asset and it does not name a quality; it describes how something is bought, how it is held and how it is priced. The same company can sit on either side of the line. So can the same warehouse, and so can the same loan. When one of them crosses over, the business does not change, the bricks do not change and the borrower does not change. The machinery around it changes: who makes the number, who is allowed to buy, what it takes to get out again, where the information comes from, and what happens to the value on all the days when nobody is transacting.

Five questions separate the two sides, and each question has an answer on each side. The private answers come from a single invented fund, worked all the way through. How a listed market works internally, how its prices are formed and how a listed pooled vehicle is run are covered separately, so the listed answers run to one sentence each.

What actually changes when something is called private?

A flat in an ordinary residential building makes the point. Every neighbour has a figure for it. The one who sold last year has a figure, the broker who keeps calling has a figure, and the relative who has never been inside the building has the strongest figure of all. None of those figures is a price. The flat has a price on exactly one kind of day: the day two people sit down, agree a number and sign. On every other day there is a figure produced by somebody's judgement, and the honest thing to say about it is that it is a judgement.

Now suppose the same flat sits on an exchange, in the sense that a buyer and a seller are standing there all day quoting each other. Nothing about the flat has changed. The plumbing is the same, the tenant is the same, the lease is the same. A number is now being made continuously by people who are willing to act on it, and that number is visible without anybody's permission being asked. The difference between the two situations is entirely in the machinery, and none of it is in the asset.

One company in this invented case actually crossed the line, so the point needs no hypothetical at all. Tungabhadra Logistics Private Limited, invented, is holding 3 of Nilgiri Growth Partners Fund II, invented. The fund bought into it at Year 2 Q2 for Rs 60,00,00,000 and held it for twenty three quarters. Through that whole stretch there was no number for it anywhere except the one the fund itself struck. At Year 8 Q1 the company made an initial public offering, and after that there was a number for it every time the market was open. Same warehouses, same trucks, same customers, same accounts.

Watch what the reporting of Nilgiri Growth Partners Fund II, invented, did around that event. For the first eleven quarter ends the holding was carried at exactly Rs 60,00,00,000, the price the fund paid for it. At Fund II's Year 7 year end it was carried at Rs 1,20,00,00,000, being 2.00 times cost. The holding was then realised in Year 8 Q1 for Rs 1,50,00,00,000 in total, being 2.50 times cost, of which Rs 60,00,00,000 came at the offering itself and Rs 90,00,00,000 from selling the rest of the shares once the lock-in ended. The reported value of that holding moved half a turn on the day it was sold, and nothing whatsoever happened to the business on that day. The number caught up with the transaction, which is the only thing a number of that kind can ever do.

Why do arguments about this subject go round in circles?

Because five different questions get argued as though they were one. Somebody says private markets are opaque, somebody answers that they get far more information than any listed shareholder, and both of them are right. The first is talking about who can see the number. The second is talking about who is entitled to the underlying detail. Visibility and entitlement are questions 1 and 4, and they have nothing to do with each other. Separating the five questions is most of the work on this subject, and once they are separate almost every disagreement heard on it turns out to be two people answering different ones.

Here are the five, and each is mechanical. One, how the number is made and by whom. Two, who may buy and what buying actually involves. Three, how and when a holder can get out. Four, what information exists and who is entitled to it. Five, what holding the thing costs and where that cost becomes visible. Not one of them is a judgement about which side is preferable.

Question 1: how is the number made, and who makes it?

On the listed side a number is a quotationA published price at which somebody is willing to deal now., and how a quotation is formed is covered separately. On the private side there is no quotation, so a number has to be produced some other way, and the way it is produced is a timetable.

Nilgiri Growth Partners Fund II, invented, ran for 8.50 years to its record date at the end of Year 9 Q2. The run covers thirty four quarter ends, from Year 1 Q1 through to Year 9 Q2. A value had to exist at each one of those thirty four dates: an administrator strikes a total and investors are sent a statement. In four of those thirty four quarters somebody outside the fund actually paid money for something the fund held, and those four transactions came to Rs 4,38,00,00,000. In the other thirty quarters nobody paid anything for anything, so every figure reported in them was an estimate of valueA figure produced by judgement on a timetable, in the absence of a price..

The thirty quarters with no price are not missing data and they are not a failure of reporting; no transaction happened in them, so no price existed to report. This is worth being precise about, because the loose version of it does real damage. The private number is not late, or wrong, or hiding something. A price is an event between two parties, and on most days that event did not occur. A vegetable seller who sold nothing on Tuesday does not have a secret Tuesday price. There was no Tuesday sale.

Who makes the estimate matters as much as how. In this invented arrangement the manager marks the holdings between annual valuations, Palani Valuation Advisors LLP, an invented limited liability partnership, values every unrealised holding annually as the independent valuation agent, and Kolar Fund Services Private Limited, invented, is the administrator that strikes the total. Three parties, on a calendar the documents fix. On the listed side the transacting itself makes the number, so no equivalent of those three parties exists.

What happens to the value on the days in between?

Question 1 has a part a reader can actually check, so the fund's own position at the record date is worth putting on the table. Total value in Nilgiri Growth Partners Fund II, invented, at the end of Year 9 Q2 is Rs 7,20,00,00,000. Of that, Rs 4,38,00,00,000 has a price behind it, being the four transactions above. The remaining Rs 2,82,00,00,000 is five holdings, being holdings 4, 6, 7, 8 and 9, that are still held and have never been sold to anybody at all. The Rs 2,82,00,00,000 is 39.2 per cent of the Rs 7,20,00,00,000 of total value, and naming that denominator is not a formality. The same 39.2 per cent of something else would be a different sentence entirely.

Say the two halves out loud and the shape of the private side becomes obvious. Sixty point eight per cent of the value of this invented fund is what somebody paid. Thirty nine point two per cent of it is what a valuation process concluded. Both are on the same statement, in the same column, in the same rupees, and they are not the same kind of claim. Nothing about that makes the second figure dishonest. The valuation figure is a different sort of figure, and a reader who treats the two identically has flattened the most important distinction here.

Notice also that the five unsold holdings are not all pointing the same way. One of them, holding 6, is carried below what the fund paid for it, at Rs 21,00,00,000 against a cost of Rs 30,00,00,000. An estimate is not a synonym for an optimistic number, and this record shows it moving in both directions. An estimate is, always, a figure produced without a transaction.

Question 2: who may buy, and what does buying involve?

On the listed side, buying is an order: it is placed, somebody is already there on the other side of it, and the money moves on settlement. The order is the whole of the listed answer here. On the private side there is no order and no counterparty waiting, and the sequence is long enough that it changes what the word buying means.

Buying starts with an invitation, the step people forget. Nobody can walk up to a private fund and ask to be let in; the fund has to ask first. Then a document is read. Then a contribution agreementThe contract by which an investor promises money to a private vehicle. is signed, and this is where the difference becomes structural rather than procedural. Signing does not move any money; it creates a promise to pay money later, when somebody else decides to ask for it.

Twelve investors and the manager promised Rs 5,00,00,00,000 to Nilgiri Growth Partners Fund II, invented. Not one rupee of it moved on the day of signing. Over the 8.50 years since, Rs 4,80,00,00,000 has been called in seventeen separate demands, being 96.0 per cent of what was promised. Rs 20,00,00,000 of the promises has still not been called at all. Think of a household that has promised a relative money for a shop that has not been built yet: the promise is real, the amount is fixed, and the bank balance has not moved. The one change is that the household cannot now spend that money on anything else.

Two figures in that paragraph sit at different levels and get confused constantly, so take them apart deliberately. The Rs 20,00,00,000 not yet called is the fund's own unfunded commitment, being Rs 5,00,00,00,000 promised less Rs 4,80,00,00,000 called. Investor 1's unfunded commitment is a completely different figure: it promised Rs 1,00,00,00,000, it has paid in Rs 96,00,00,000, and Rs 1,00,00,00,000 less Rs 96,00,00,000 is Rs 4,00,00,000. One figure answers for the fund and one answers for a single investor, so the two are five times apart and both are correct.

Question 3: how does anybody get out, and when?

On the listed side, getting out is a sale at a price already showing, whenever dealing is open. The sale is the listed answer in full. On the private side there is no price already showing and nobody standing ready, so getting out is a transaction that has to be built from nothing, and the record of this invented fund shows exactly what building one involves.

Five positions left Nilgiri Growth Partners Fund II, invented, in 8.50 years. Holding 2 went to another fund in Year 6 Q3 for Rs 63,00,00,000. Holding 5 was written off in Year 6 Q4 for nothing. Holding 1 went to a buyer already operating in the same industry in Year 7 Q2 for Rs 2,03,00,00,000. Holding 3 was offered to the public and then sold down in Year 8 Q1 for Rs 1,50,00,00,000. And 40 per cent of holding 9 was sold in Year 8 Q3 for Rs 22,00,00,000. Every realisationThe event in which a private holding actually becomes cash. in that list needed a named counterparty who had to be found, persuaded and agreed with.

Each of those five exits required a specific person on the other side of it, and until that person existed the position could not be turned into money at any price. A food stall outside one office building can be sold, but only to somebody who wants a food stall outside that particular building, and the seller cannot make that person appear by wanting to sell more urgently. The narrowness is not a defect of the stall, but what having one counterparty rather than a crowd of them means.

Two details in the list are worth pausing on. The first is that holding 9's sale covered 40 per cent of the position and not all of it. A count of positions and a count of exit events are therefore not the same count in this fund: four holdings have gone entirely, five are still held, and there have been five exit events, because holding 9 sits on both sides. The second is that a write-off is on the list at all. Nobody paid anything for holding 5, and it is still an exit in the only sense that matters structurally: the position left the portfolio.

Question 4: what information exists, and who is entitled to it?

On the listed side information arrives by publication, under a rule of general application, reaching every holder at the same moment whoever they are. Publication is the listed answer, and the listed world is covered separately. On the private side, information arrives because a contract says it must, and the contract was negotiated by one holder for itself.

Nilgiri Growth Partners Fund II, invented, negotiated seven reserved matters into the shareholders agreement of all nine of its holdings. Each one is a thing the company may not do without the fund's written agreement: issuing new shares or anything convertible into shares; selling the business or a material part of it; borrowing above a limit each agreement sets; changing the constitutional documents; appointing or removing the chief executive or the chief financial officer; approving the annual budget; and entering any transaction with a related party. Alongside them, each company reports to the fund on a timetable that agreement fixes. The contents of that reporting, and what the fund in turn sends its own investors, are covered separately.

The structural point is not that one arrangement produces more paper than the other; it is that one is a rule nobody at the table wrote and the other is a term one party wrote for itself. Think of a wedding caterer with a printed rate card that everybody sees, against the same caterer agreeing a written schedule of tastings, staffing and penalties with one particular household. The second is more detailed for that household, and it is more detailed because that household asked and negotiated, not because written arrangements are naturally richer than published ones.

Question 5: what does holding cost, and where does the cost show up?

On the listed side a charge is stated as a rate and taken before the number a holder is shown, and that is the listed answer here. On the private side the cost is drawn as capital, arriving as a demand for money alongside the demands that buy things. The cost becomes visible only when the same numerator is divided by two different denominators.

Here is the arithmetic, and it is two divisions on figures already given above. Nilgiri Growth Partners Fund II, invented, holds total value of Rs 7,20,00,00,000 at its record date. Its nine holdings cost Rs 4,00,00,00,000 to buy. So its multiple on costTotal value divided by what was invested, ignoring every fee. is Rs 7,20,00,00,000 over Rs 4,00,00,00,000, being 1.80 times. But investors were not asked for Rs 4,00,00,00,000. Investors were asked for Rs 4,80,00,00,000, so the multiple on paid inTotal value divided by everything the investor actually paid. is Rs 7,20,00,00,000 over Rs 4,80,00,00,000, being 1.50 times.

The Rs 80,00,00,000 between those two denominators is the entire cost of holding this vehicle for 8.50 years, and it is the management fee of Rs 70,20,00,000 plus fund expenses of Rs 9,80,00,000, drawn on top of every rupee that bought anything. How that fee is set, and what its basis does over a fund's life, are covered separately. Where the fee went is what matters: not into a line on a statement headed charges, but into the denominator of the second division.

A third reading exists. Almost nobody quotes it, and that is exactly why it is worth knowing. Investors and the manager promised Nilgiri Growth Partners Fund II, invented, Rs 5,00,00,00,000, and Rs 7,20,00,00,000 over Rs 5,00,00,00,000 is 1.44 times at the record date. One fund, one day, three arithmetically correct answers: 1.80, 1.50 and 1.44. A number quoted from that set without its denominator attached has said almost nothing, and this is the single most common way a reader is misled on the private side without anybody saying anything false.

What do the five questions look like from one investor's seat?

The five answers above are the fund's. An investor of that fund sees the same five mechanisms from further back, and putting one investor's own position on the table makes them concrete. Investor 1 of Nilgiri Growth Partners Fund II, invented, is a domestic life insurance company that promised Rs 1,00,00,00,000, or 20.0 per cent of the fund's Rs 5,00,00,00,000 of commitments. Because every call in this fund is made strictly pro rata, its position at the record date is the fund's position scaled by exactly one fifth.

The line that is not on that statement, and that a reader has to supply, is what the Rs 56,40,00,000 is an estimate of: five holdings, one of them written down, none of them sold to anybody. Every other line has a transaction behind it. The unsold line has a valuation process behind it, and the difference between those two sentences is question 1 arriving on a single investor's own statement. The 1.50 times at the bottom is the multiple on paid in of Nilgiri Growth Partners Fund II, invented, and it is the same figure only because this fund draws pro rata and no side letter moves investor 1's economics.

How does somebody actually use these five questions in a room?

An analyst is handed two numbers and asked whether they can go in the same table. One is a listed holding at a closing level and one is a private holding at a carrying value. The five questions are the fastest way to answer, and the answer is usually yes with a note attached rather than a flat no. The note says which of the five differ between the two rows, and a table with that note is honest in a way that a table without it is not.

Question 1 tells the analyst that one figure is a price and one is a judgement, so a movement in the second may be a change in the underlying thing or may be a valuation date arriving. Question 3 tells a treasurer whether the number can be turned into cash by Friday, and that is the question a treasurer actually has. Question 5 tells anybody reading a performance figure to ask what the denominator was before they compare it with anything.

A lender doing the same exercise reads it slightly differently. A lender wants to know what the security can be turned into and how long turning it takes, so question 3 is the one that binds. Question 4 is the one that helps. A private holder with contracted information rights can often answer a lender's diligence question faster than a listed shareholder who has only what was published. And a household with an inherited stake in an unlisted business is living all five at once: no quotation, no order, no exit without finding somebody, information only if a shareholders agreement gives it, and costs that appear as money asked for rather than as a rate on a statement.

Which comparison of the two sides can this record actually support?

The arithmetic underneath it is two totals and a division, and neither total is a return. Every contribution the fund called was carried forward to the record date at that invented index's own movement, giving Rs 7,35,21,00,000. Every distribution was carried forward the same way and the residual value was added as it stands, giving Rs 7,71,39,00,000. Divide the second by the first. Two totals and a division are the whole instrument, and notice what the instrument never asked: it never asked how long anything was held, it never asked which holding produced what, and it never asked whether the residual Rs 2,82,00,00,000 could actually be sold for that.

What else does one fund's record not support, and why?

There is a second claim that is much easier to make by accident than the first one, and it hides inside a true observation. Nilgiri Growth Partners Fund II, invented, reported thirty four values in 8.50 years. A listed holding reports one every time somebody deals. Somebody looking at those two series side by side will see one that steps and one that jitters, and the sentence that arrives almost by itself is that the private one must be calmer. The conclusion does not follow.

A mark struck four times a year is a measurement interval and not a property of the thing being measured, so a private holding is not calmer, steadier, smoother or less volatile than a listed one on this evidence. A listed share measured four times a year gives a line with four points in it too. The warehouses of Tungabhadra Logistics Private Limited, invented, measured every second, would not stop being warehouses. Such a line shows the sampling rate, and reading a property of the asset off it is exactly the mistake to avoid.

Two further boundaries belong beside that one. The conditions for getting registered, listed, admitted or dealt with on either side of the line are set by a regulator and change, so they are read at the source. And one fund's record over one period says nothing about whether either side suits any particular holder, because suitability is a fact about the holder and this record holds only facts about the fund.

Where does all of this leave the reader?

With five mechanical questions and a habit. The habit is to ask, of any number presented, which side of the line it was made on and by what process. One question separates a price from a judgement, an order from an invitation, a sale from a negotiation, a publication from a contract, and a stated rate from a gap between two denominators. Every one of those five distinctions is observable, none of them is a verdict, and a reader who holds all five can read a private arrangement and a listed one without ever needing to decide which is better.

And the organising idea survives all five questions. Nilgiri Growth Partners Fund II, invented, holds nine businesses. One of them ended up on the other side of the line while the fund still had it, and the trucks kept running. The word private was never describing the trucks.