By the time it went public with a stock exchange listing in 2012 Facebook was worth $104 billion. The social media giant’s stock is now worth over four times that but when Peter Thiel invested $500,000 in 2004 it was at a valuation of around $5 million. By May 2005 the company had raised $12.7 million in venture capital from Accel Partners at a valuation of $100 million. In 2009 Elevation Partners bought in for $90 million at a valuation of $9 billion. And in 2011, Goldman Sachs and DST invested $500 million at a $50 billion valuation.
So by the IPO the following year the last investors while the company was still private had more than doubled their money. And early investors? Accel sold just 17% of its stock for $516 million in 2010, 2 years before the company listed on the stock exchange. That’s 17% of the stock acquired for $12.7 million in 2005.
Spotify listed on the NYSE last year having already reached a valuation of $29.5 billion. Uber, Lyft and Pinterest are gearing up for public listings this year with valuations forecast at $120 billion, $20-$30 billion and $12 billion plus respectively. Airbnb’s plans to go public were delayed last year but a new CFO means they could well be re-ignited this year. And with a valuation of over $30 billion as a private company when it last raised investment in 2017, a move to the stock market would be expected to target a valuation of well over $50 billion.
More Companies Than Ever Remaining Private and Out of Reach For Everyday Investors
And more and more companies are staying private until their valuations reach far more than $1 billion. There are plenty of upsides to remaining private. The biggest, expounded by Elon Musk last year when he threatened to de-list Tesla and take it back private, is the short-termism of capital markets.
Young companies still developing their core products and markets often struggle with investor demands for immediate returns and focus on growing turnover and profits. An increasing number of founders just don’t want that pressure and Airbnb is a perfect example, having delayed their IPO for several years. Stockbroker Cannacord Genuity says that the number of companies publically listed on stock markets in the USA has fallen 50% from the peak in the 90s. In the UK it’s a whopping 71%.
Risk To Reward Investing In Private Companies
But looking at the success stories, the obvious conclusion is that there is a lot of money to be made by investing in the right companies while they are still privately owned. Even more if you get in early. That of course ignores the fact that for every Facebook, Airbnb, Spotify, Uber or Lyft there are thousands of failed start-ups. Just ask anyone who’s invested through crowdfunding platforms. There are success stories there too.
Craft beer company BrewDog is a perfect example, having raised investment through 5 crowdfunding rounds. The last in 2018 brought a massive £26 million into the company’s coffers. Around £60 million in total investment has been raised from 78,000 small investors. A 22% stake was also sold to U.S. private equity house TSG Consumer Partners last for £213 million at a valuation of £1 billion. Later fundraising has been at even higher valuations. £1 billion was a punchy valuation given that profits were just £1.4 million, having fallen from £3.8 million due to major investments such as in production facilities. However, it’s pretty sure TSG made sure they got a strong class of shares with full voting rights for their investment.
Not so much the case for investors that bought equity through the crowdfunding campaigns. There has controversy that terms and conditions for crowdfunding investors limits their upside. Those who participated in the last crowdfunding campaign on Crowdcube bought shares at a higher valuation than £1 billion. But not the same kind of shares as TSG acquired. Crowdfunding investors receive ‘B class’ shares which do not carry the same rights as standard equity. The biggest criticism is that shareholders do not have the right to buy future equity at the same price as being offered to new investors if they consider them undervalued. This mechanism helps protect early investors and the valuation they have bought in at.
Directly holding small amounts of Brewdog equity also means small investors are more or less locked in until the company is sold on or bought out in its entirety. Unless they go to the time and trouble of trying to sell privately, which is difficult when holdings are modest. Funds that own equity worth millions can, even if much more slowly than exchange-listed equity, usually find a buyer if they want to sell earlier.
Like when Accel sold 17% of its early Facebook investment at a huge profit a couple of years before the IPO. This meant they were protected. A huge return on the initial investment was already secured and the company could then leave the rest of the investment in play, secure in the knowledge that whatever happened thereafter, a big win had been recorded. It’s not as easy to sell on equity in a private company when what you own is worth a few hundred or thousand pounds.
Private equity is highly risky. Especially if the company invested in is young. But even buying into an established private company carries much more risk but holdings are illiquid. If investors realise things are going downhill, the can’t sell shares on a public exchange at the click of a mouse. Finding a buyer for a private placement takes time and by that point the cat may well be out of the bag and the company’s valuation plunged.
Even the most successful venture capital and private equity investors that invest in early stage start-ups make a loss on many more companies than they make a profit on. And investors in more established private companies also get burned by falling valuations if performance and market conditions change. But those that know what they are doing get enough of their calls right to do very well out of the winners.
Investing in Private Equity As A Retail Investor
So is there a solution for the everyday investor that allows those investing online in SIPPs and ISAs to gain exposure to private companies while they are still at the stage where their valuation multiplies annually? Without having to invest hundreds of thousands or millions and having to do due diligence personally or hire someone at great expense to do it for you?
Thankfully, there is. A number funds are specialised in investing in private companies and others allocate a chunk of their capital to this asset class. Like private companies, many private equity, venture capital funds and hedge funds that invest in private companies are not exchange-listed and you can’t just buy into them. They usually either have minimum investment thresholds in the hundreds of thousands or millions and are not necessarily open to any investor. Though practically speaking, if you do have fairly begotten millions and want to invest them in a closed fund the chances are your money is not going to be turned down!
However, there are also funds formed as unit trusts, investment trusts and ETFs that invest in private companies and are perfectly suited to retail investors – people like you and me investing online into SIPPs and ISAs. Shares can be bought in them through online investment platforms. These funds employ teams of analysts to do the due diligence and are experienced in picking the young private companies that will go on to make it big. It might not be as fun as investing directly through a crowdfunding platform but it’s much less risky and you can be sure that the fund, as a major investor, will negotiate favourable terms that protect their and your interest.
Best Funds To Invest In Private Companies
As has been mentioned already, investing in private companies is a high risk to high reward approach to investment. As such, it is probably wise to only allocate a limited percentage of your investment portfolio to private equity funds. The higher risk section chasing the big wins. The risk to reward ratio of investing in private companies is demonstrated by the huge divergence in the returns achieved by funds in this asset class.
According to data from Trustnet, the funds research company, the average 5-year return for private equity investment trusts was 52.6%. At over 10.5% per annum, that’s a strong showing. However, the difference between the best and worst performing funds in the class is huge. The best, 3i Group, handed investors a return of 186.6% over the last five years. The worst, Better Capital, lost 70.6% over the same period.
A recent article in The Times newspaper invited 3 experts to highlight the private equity funds they like best. The results were as follows:
William Heathcoat Amory, Kepler Partners:
- ICG Enterprise
- Standard Life Private Equity
Alan Brierley, Canaccord Genuity:
- arbourvest Global Private Equity
- Pantheon International
Jason Hollands, Tilney Group:
- iShares Listed Private Equity UCITS ETF