Private capital markets: Where the real ROI is

Returns on investment are now concentrated during private ownership of companies

Source: Andreessen Horowitz

There has been, over the past 20 years or so, a big shift in where the bulk of returns are created by some of the world’s most prominent tech businesses. Larger inflows capital into private markets — that is, more money being invested in private companies — means that these businesses are remaining private for longer; they’re delaying their initial public offerings (IPOs) because they don’t need the money that IPOs generate.

Think about it: as the founder of a company, why would you relinquish control of your business with an IPO when there are plenty of investors lining up to give you cash? You can continue to shape and direct your business without having to answer to public shareholders and become profitable to provide returns.

This is a big reason why there are so many “unicorns”, private businesses valued at over a $1bn, and decacorns” with $10bn-plus valuations are becoming more common. In the past, high-growth companies would have IPO’d well before they reached such sky-high valuations.

Why does this matter? Well, since businesses are remaining private longer this means that they are achieving growth, and thereby creating value, while they remain in private hands. By the time they eventually do IPO  and become an investment option for the general public,  growth will likely be slowing. And it is growth that makes investors money.

Take a look at the above graph put together by the prominent VC firm Andreessen Horowitz. Tech giants Apple, Microsoft, Oracle, and Amazon, all of which went public in the 80s and 90s, created significant amounts of ROI after they IPOed. Conversely, Google, LinkedIn, Facebook, and Twitter created almost all of their value while still private companies.

Here’s salient example: Amazon went public in 1997 with market cap of $438mn. It’s market cap is now $267bn — huge amounts of growth has occurred while public. Chinese e-commerce giant Alibaba went public in 2014 with a market cap of $155bn, over 350 times higher than Amazon’s market cap in 1997.

In order for Alibaba to yield the same ROI for investors as Amazon did (based on their 2014 market caps), it would need to grow their market cap to somewhere in the ballpark of $71 trillion — that’s $71,000,000,000,000 — by 2032. Not likely.

So what’s the lesson for us investors?

Gone are the days of high return-generating public equities. The money is to be made by investing in private businesses.

Accessing private deals has long be limited to the wealthy, connected few. However, with the emergence of equity crowdfunding, people across the globe are gaining access to early-stage business and SME private equities; they are getting an opportunity to hit it big with a growth-oriented company, just like the guys in Silicon Valley.

The space remains nascent and has a lot of maturing still to do, but it is a great source of private equity deal flow and an easy-to-use vehicle for investing in promising businesses before they’re acquired or go public.

***Remember, this is a high-risk, high-reward asset class so it needs to make up only a small portion of a well diversified investment portfolio to mitigate risk. And your portfolio of private equity investments needs to be well diversified as well — we suggest a minimum of 10 quality portfolio investments, but the more the better.Start Crowdinvesting

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