Have you ever been exposed to an investment opportunity that at the time seemed wildly impractical, but then years later technology and innovation elevates the opportunity in a more accessible format?
Private markets investing — or, better said, investing in anything that is not available in public markets on an exchange — has been a source of investment alpha and wealth creation since the beginning of time. But historically within private markets, the ability to own actual shares of a nonpublicly traded private company has been limited to limited partners or insiders.
The opportunity
Today, accessing private shares of companies like Anduril Industries, Stripe Inc., Epic Games and Addepar is both practical and perhaps necessary for investors to consider as a component of their portfolio. The expansion of this opportunity has been driven by the well-publicized fact that high-quality companies are staying private for longer — which is forcing those companies to allow its shareholders to find ways to access liquidity, sell shares to exercise options and, importantly, diversify holdings.
According to CB Insights, there are over 1,200 private companies worldwide with valuations exceeding $1 billion and almost 50 companies with valuations over $10 billion. These companies often have multiple institutional venture investors, proven business models and, quite often, significant profitability.
While acknowledging the risks of private share ownership — such as illiquidity, lack of financial transparency, valuation uncertainty and diligence challenges — there are many attributes that make investments in private companies compelling.
Private markets can offer higher returns compared with public markets due to the illiquidity premium and the ability to invest in promising early-stage or pre-IPO companies or undervalued assets, often at a discount to recent valuations. A quality factor overlay can be applied with direct secondaries, versus blind pool investing in venture funds.
If your investment thesis is tech-focused, it is important to recognize where the real value creation occurs in many companies. According to a University of Florida study, the majority of value is realized pre-IPO. And to the extent that companies stay private for longer, mature tech companies are creating tremendous value while staying private.
The same study references the median age at IPO now is 15 years.
The hurdles
From my research, two of the primary hurdles in this approach are due diligence and diversification. This is where innovation has provided investors new options.
From a diversification perspective, several companies have created pooled vehicles, such as traditional LP funds and closed-end interval funds. Firms like Ark investment Management, Destiny and other fund sponsors are touting their expertise in access and due diligence. Additionally, trading platforms such as EquityZen, CartaX and Forge Global provide access to qualified investors, representing their expertise in diligence and access.
Recently, Forge Global partnered with a firm specializing in the space — Accuidity — to launch the Forge Accuidity Private Market Index, which tracks 60 of the top venture-backed private companies. Accuidity offers the Megacorn fund, an institutionally managed index fund seeking to replicate the performance of the Forge Accuidity Private Market Index, providing diversified access to direct share ownership.
I asked Accuidity co-founder and President Vince Gubitosi about the opportunities and challenges that they have encountered in building out his firm.
“Our team has decades of indexing experience, and the process of creating a true private markets index has been both challenging and rewarding,” Gubitosi said. “Cutting through the noise of the private markets space, creating a paperless investor experience and partnering with firms like Forge are allowing us to serve an important role in matching capital with opportunity.”
Not all are equal ...
I have also learned a great deal about the different ways in which firms and sponsors represent their interests in companies like SpaceX and Databricks. This can range from “on the cap table” units to synthetic exposures.
Recently, a colleague with another family office admitted that they thought they were in a late round of a prominent company, only to find out from the company’s CFO that their sponsor was not on the cap table at all. They were in a special purpose vehicle (SPV) that owned units in another SPV. Now the investment may work out, but the cost to access is astronomical.
The investor should know whether the shares/units are primary or secondary, common or preferred; and to the point above, whether the shares are on the cap table or held through an SPV.
An SPV is fine, of course, assuming the underlying exposure is real, the fee structure is reasonable and the sponsor/GP has real money on the table. To support the importance of understanding the structure, Gubitosi said: “We prioritize direct cap table exposure on our investments and do not employ any synthetic exposure. If we choose to utilize an SPV, we will rely on our own diligence and partnerships with firms like Forge.”
... and not for everyone
Direct ownership in secondary shares is generally limited to what the Securities and Exchange Commission defines as qualified purchasers or perhaps the lower bar of accredited investors. However, it seems inevitable that the broader — dare I say, retail market — will get in on the game. Of course, there are regulatory changes necessary to allow this to happen.
Consider this: If there are less than 4,000 publicly traded companies available to U.S. investors, and there are over 1,200 venture-backed private companies with valuations exceeding $1 billion, is it not compelling to find a way to add those companies to the investment universe? It certainly broadens the pool of options and improves access to the capital markets for all