The year has started with heightened volatility given changing monetary policy, inflationary pressures, and geopolitical risk, but there are positive signs in the market. However, strong jobs and wage growth, healthy corporate balance sheets, and a reset in private valuations should present compelling investment opportunities.
Investors that are deploying capital now are entering the investment at a compressed valuation (lowering the cost basis) which may provide the same or better returns with lower hurdles (commonly referred to as “the goalposts”). A 3x return on a $500m investment looks very different from a 3x return on a +$1bn investment.
Retail investors may be even more likely to turn to the private markets as they consider the current performance of their public stock portfolio. Two common approaches that may present more risk than investors are aware of:
SPV’s
Many investors may invest more heavily in SPVs run by managers with no skin in the game (not deploying any of their own money into the deal).
SPVs can bundle together any type of investment opportunity, including those that may be high risk or have little oversight and governance. This can lead to investors taking on more risk than they may be aware of or comfortable with.
Secondary Common Stock
A commonplace you see individual investors look for private market exposure is by investing in secondary common stock (ie, purchasing an employee’s exercised options) which are many times sold based on the last preferred equity round.
There is a big difference between the underlying value of preferred stock and common stock, and with companies raising capital at lower or flat valuations, the holder of the common stock will have a much larger preferred overhand given they get priority on proceeds (and often times will have a ratchet in late-stage funding rounds).
A More Prudent Approach
Investing alongside managers who have experienced multiple economic cycles and have the discipline to follow a sound long-term strategy is key to retail investors capturing returns in today’s private market environment.
These managers that have discipline on price, ownership, and selection, enable retail investors to build portfolios of private market companies with strong advisory teams who understand their businesses, have a perspective on the broader market outlook, and the experience and perspective to weather volatility.