Traditionally, investors have had 2 options for investing in high growth tech companies:
- Live in a city with a vibrant early stage technology ecosystem, know the right people, and get access to companies as they emerge. This setup has been available only to a select few.
- Purchase shares when the company goes public.
Expansion and growth stage deals (like the funding round Uber recently raised) have long been out of reach for most investors. Recently, online platforms have opened up opportunities for more investors at the seed stage, expansion and growth stage opportunities remain out of reach for all but the largest institutional funds; and tech IPOs are infrequent.
To explore these trends, let’s first take a look at what is occurring in the late stage private markets. While these deals are largely inaccessible to individuals, they are having a major impact on developments both up (IPOs) and down (seed stage) the venture stack.
1. There are more than 75 venture backed private companies valued at over $1b
While some of these companies will likely fail to live up to expectations (and valuations), many of them fit the profile of what an IPO company would have looked like a decade ago – growing revenue, profitable unit economics, and large market opportunities. A desire to maintain founder control and build without having to please Wall Street or comply complex regulatory and accounting requirements has led many of these companies to push off going public. This means less access to high growth deals in the tech deals in the public market.
2. Growth stage rounds are being populated more and more by corporate investors
The amount of corporate venture investment is on pace to hit multi-year highs and a significant portion of that capital is being invested in late stage companies. These investors – standalone corporate funds or those investing off the corporate balance sheet – seem to have more of a focus on planting seeds for lucrative business development relationships than on generating returns, making them less sensitive to valuations.
3. Traditional public market investors (asset managers like BlackRock and TD Ameritrade) have started investing in late stage private deals
This trend has emerged in response to the first trend, as like corporate VCs, these massive asset managers have been less sensitive to entry price, meaning that once these companies finally do hit the public markets they will be fighting to justify massive valuations and the opportunities for investors to participate in meaningful growth will have vanished.
So what do these trends tell us about investing in the private markets? Two things 1) the majority of value creation is happening at the early stage and 2) later stage deals – whether in private or public companies – do not offer investors risk adjusted returns that match a thoughtfully diversified portfolio of early stage companies.
Look at returns for early investors in Uber to see why this is true. When the company hit a valuation of $17b in late 2014, it was reported that investors in the company’s first round had seen their money grow 2,000x. That’s more than a home run, better than a grand slam. The company’s most recent round valued the company at almost $51b—a nearly 6000x return for early investors. It would take a valuation of $306 trillion for late stage investors to match that return (and then early Uber investors would have a 36,000,000x –that’s 36 million – return, so early stage wins big again).
Finding the next Uber, even for thoughtful investors with reliable access to early stage investing opportunities, is tough. But as the Cambridge Associates LLC U.S. Venture Capital Index, a comprehensive survey of the performance of the U.S. venture market, shows, early stage investments still provide higher expected returns than other asset classes.
Across most time periods, especially the long term, early stage investments outperform other private stages as well as public market indices like the S&P 500. Value creation in the economy at large has been (and likely will continue to be) driven by smart founders with a vision, talented teams executing on that vision, and investors who fund the vision early.
Looking for more insight on getting started with early stage investing? Take a look at the presentation below.