The Pre-IPO Startup Equity Market

The Pre-IPO Startup Equity Market

The Pre-IPO Startup Equity Market

IPO market geared up for the busiest week

In a low-yield world, is Pre-IPO investing the hidden secret to higher yields?

  • Pre-IPO secondary transactions are growing, and over past few years have consistently generated higher returns over other traditional asset classes
  • Startups are remaining private longer. The average age of technology companies going public has gone from 4 years in 1999 to 11+ years now. As a result, several broker networks and pre-IPO marketplaces have emerged to provide liquidity to early stage investors and employees
  • Our analysis shows that secondary investments in mature startups 2-3 years prior to a liquidation event have yielded between 40%-70% annualized returns with fairly high success rates. That’s not a typo!
  • Case in point – Slack went public with IPO priced at $38.5 per share, earning around 200% above the last private funding round 10 months prior to the IPO.

However, investing in Pre-IPO is no silver bullet. Just like all other forms of investing, you can go wrong and will go wrong. Imagine investing in AirBnB in 2017, or in Bytedance in Dec 2019. AirBnB’s valuation has halved since, while Bytedance has taken a nosedive.

Is Pre-IPO investing the hidden secret to higher yields? Is it a promising asset class that can consistently deliver returns for private investors looking to invest in high quality high growth unicorns headed for a liquidity event in 12-24 months? What are the key risks investors should be aware of?
We did an in-depth analysis of the past performance of this market in order to quantify potential returns, as well as look for potential pitfalls. This report provides a complete analysis and our point of view of the Pre-IPO secondary market, its intricacies and future prospects.

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    Busting the 60:40 myth

    Busting the 60:40 myth

    Busting the 60:40 myth

    Why private assets are emerging as an alternative for HNI investors

    • Private Equity returns have beaten public market returns over the last 10, 15 and 20 year period
    • A 30-year investment of 10,000$ in S&P 500 would amount to 76,312$, whereas the same amount in a private equity fund would become a whopping 211,071$ – a 20x return
    • Individual investors allocated less than 5% of their investments to alternatives, compared to 26% by pension funds and 57% by endowment funds. America’s largest public pension plan, CalPERS put $7 billion into private equity during the 2018-2019 fiscal year. “We need private equity, we need more of it, and we need it now,” chief investment officer Ben Meng said in early 2019
    • The case for alternatives is well understood by HNW (High Net-Worth) investors: for instance, 67.5% of the registered investment advisors surveyed said their HNW clients are interested in private equity. And yet, on average only 10% of their client base is investing in private equity funds
    • In view of worldwide rising volatility and disruption, alternatives are well suited to create value through selection and a record 1.7 trillion dry powder ready to invest
    • Disruptive technologies, such as artificial intelligence, are helping fund managers to improve operational efficiencies while creating new opportunities for investment

    Over the past 20 years, alternative investments have surged tenfold from a trillion dollars to 10 trillion USD compounding roughly at 12% per annum and slated to grow to 14 trillion USD by the year 2023. 

    You may ask what are alternative investments? Alternative investment is a financial asset that does not fall into traditional investment categories like stocks, bonds or mutual funds. These include, but are not limited to private equity, private debt, hedge funds, real estate, infrastructure and natural resources.

    Over the last few decades private markets have grown significantly in scale and complexity and are rife with opportunities. Quite simply put, alternative investments provide higher returns and lesser volatility as compared to private markets as we can see from the data of the last two decades.

     Source – Committee on Capital Markets Regulation and Voya Investment Management (October 2017)

    By investing in alternatives, an investor can easily diversify their portfolio and control risks. According to a study published on PlanAdviser.com, more than half (53%) of millennials favor alternative investments over ‘traditional diversification’. People all over the world are realizing the potential of such investments and the train is about to leave the station. Googling “liquid alternatives” yields 119 million results in half a second.

    The pandemic has ruined businesses and all over the world, companies in certain sectors are being sold for cents on the dollar. Private equity companies are sitting on a cash pile of 1.7 trillion USD and are ready to take advantage of these distress opportunities and primed to push for higher deal-making. According to a PwC report, PE firms are looking to increase investments across TMT – technology, media, and telecom in the coming months as the sector has shown more recession resiliency relative to other industry groups.

    Further reasons why seasoned or ‘accredited investors’ should make the shift towards alternatives are:

    Public Markets are overcrowded and expensive – Over the last 10 years, stock market valuations have kept on increasing year on year and as of September 11, 2020, the P/E ratio of S&P 500 has reached 28.72 compared against the historical average between 13 and 15. Overcrowding in the public markets has led to such high valuations and earnings are simply not matching up to these crazy valuations. For example, TESLA trades as 970 times its earnings, and Hilton Hotels trades at 728 times its earnings. There are fewer public companies (number of listed companies have decreased 39% in the last 25 years) and companies are waiting much longer in their life cycle to go public (average age of US tech cos which went public was 4 years in 1999, which had risen to 11 years by 2014).

    Private Markets Opportunities Growing – There are around 400 unicorn startups (private companies that are valued above $1 bn). With large companies and funds willing to back these companies, they don’t have a huge incentive to go public to raise funds. These companies are remaining private longer because it allows them to think and act more strategically, which means that equity investors have less access to the market as a whole. Alternative investments allow individual investors to gain access to this asset class which is designed to take advantage of volatility, dispersion, and dislocations are particularly well suited and may provide returns that have low correlations to traditional betas. The industry has crossed the 10 trillion barrier and with over 12,000 active alternative asset management institutions, the numbers are just going to grow. Furthermore, more and more fund managers are deploying artificial intelligence & machine learning (AIML) technologies to stay ahead of the curve.

    More sources of information available to investors – Individuals have much higher access to information regarding private markets. There are hundreds of financial research software that can help an investor conduct proper due diligence on private companies as well as private equity funds. Some of the most used databases are Pitchbook, CB Insights, Mattermark, Tracxn, S&P Capital IQ, Eikon, and the Bloomberg Terminal. Apart from providing investors with quality data, some of these platforms also allow for making models and risk analysis. The free internet also has huge coverage of private companies and markets which enable an investor to make a rational decision.

    Change in regulations paving way for easier access to private markets – The Securities and Exchange Commission in the USA is changing the way alternative investments are going to be regulated. Chairman Jay Clayton has said he’s eyeing an overhaul of all regulations around private placements, with the intent of making them more accessible to individual investors. It appears the democratization of alternatives is an SEC priority. In fact, its December press release recognizes the key role that pooled investment vehicles, including private and regulated funds, can play in providing a more level playing field for individual investors and allow them to gain from excess or uncorrelated returns from participation in the private markets. The European Commission has issued its much-awaited report on the Alternative Investment Fund Managers Directive (AIFMD). The report is short – only six pages of substance – but gives a clear sense of the direction of travel.

    Asset owners’ evolving needs – Asset owners are looking for ways to optimize their alternatives allocations, with goals that extend beyond performance and diversification. In many instances, investors are seeking strategic relationships with alternatives managers that have the potential to create value on several levels. Investors want to invest in causes or technologies they are personally interested in. The new-age investor also wants to invest in companies following ESG (Environmental, Social, and Corporate Governance) norms. According to consultancy firm Mercer, more than three-quarters of respondents (76 percent) incorporate ESG criteria when investing in alternative asset classes and that most believe ESG improves risk-adjusted returns and is an important aspect of risk and reputation management. New platforms are emerging which allows for customization in the alternatives. iCapital in the US, Moonfare in Europe, and Torre capital in Asia are changing the way people invest in alternatives.

    While we advocate for allocation to alternatives, we don’t want to wish away the inherent risks. Some of the risks while investing in private markets are:

    Illiquidity – While private markets are gaining higher liquidity over time with the deepening of the secondary market and lingering overhaul of regulations, certain assets in private markets are highly illiquid and an investor must be aware of the amount of time their capital may be locked for 5-10 years. Only dedicate that portion of your portfolio which you are comfortable investing for long term, and where a little bit of volatility would not unnerve you. 

    Smart Allocation: We at Torre Capital do not recommend investors to allocate more than 10% of their portfolio to alternatives across asset classes. It is always better to ask for advice and understand the role of alternatives in your portfolio given your current asset allocation and your financial goals before you make your first investment. Smart allocation that allows you to stick to your investing plan would always yield higher returns than investing just based on returns offered or relative “hotness” of an asset class. 

    Novice Effect – During the cryptocurrency mania in 2016, everyone wanted to jump on the bandwagon rather than regret missing out on a huge opportunity and a lot of amateur investors lapped up various cryptocurrencies only to suffer a major crash and lull for a long-time. Although interest in alternatives is heating up, novice investors should do proper due diligence of where their money is going and not bet on gambles promising enormous returns. 

    Manager Selection – Manager selection in alternatives matters. Unlike in public equities, where the difference between top- and bottom-quartile managers in any one-year averages about 2.5 percent, in private equities that spread approaches 20 percent. Picking the right or wrong manager matters hugely if an investor is looking for discretionary portfolio management.

    We at Torre Capital pride ourselves on our promise to always look out for our investor interests. Irrespective of incentives offered, we only bring investments that make sense for our investors. Our motto is principal preservation over principal protection, and we conduct multiple levels of due diligence before offering an investment on our platform. We request you to always do your homework before investing, and reach out to us in case of any queries! 

     

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    What is the motivation behind Torre Capital?

    What is the motivation behind Torre Capital?

    What is the motivation behind Torre Capital?

    Here we take a look at why we see a need to start an investment platform and why we are on a path to revolutionize access to alternative investments

    In my erstwhile career as a Digital Consultant with first Accenture Digital and then Mckinsey, I have had the privilege of building Digital Banks and Fintech platforms from scratch. There were two key takeaways I had from all these experiences put together:

    • Digital channels, if used efficiently, could transform the customer experience by offering better products at a much lower price point by eliminating useless intermediaries.
    • By the time any financial instrument reaches retail hands, a large portion of the profit pool has already been siphoned off. It is a rather simplistic but fairly accurate argument that institutions benefit from early access to investments, which at a later stage gets distributed to unsuspecting retail investors.

    I went looking for a white space in the finance industry armed with these two hypotheses, and soon found one.

    Over a period of six months from January 2019 – June 2020, I personally spoke to over 200 High networth investors and about 50 family offices across 5 APAC countries. The entire group had a few complaints and requirements:

    Issues with current wealth managers:

    • If they didn’t offer their entire portfolio to one private bank, they wouldn’t take them seriously. Anything short of double digits, and you won’t get the advisory or access you need
    • Mostly unsure on how much trust to place on their Relationship Managers.
    • High and opaque fee structure which made returns look ordinary.

    What do they really want:

    • Institutional Access to exclusive products that helped enhance portfolio returns but without the potential of steep drawdowns. Not equity baskets or mutual funds that everyone else is offering under the garb of managed AUM or roboadvisory.
    • Clear and unambiguous understanding of products on offer. No opaque language or unnecessary jargon
    • Clear and transparent pricing that doesn’t try to fleece at the cost of returns. No kickbacks to funds or investment managers
    • An easy self-directed process to invest using digital channels rather than being chased by Relationship managers
    • Support who is readily available and knowledgeable to answer queries, handhold during the investment process. But no hard sell or repeated follow-ups

    Ergo! Torre Capital

    We built Torre Capital with the sole intent of providing a platform that looks out for investor interests before anything else.

    We bring our investors access to asset classes at low minimums so that they can invest even with modest portfolios. We do with only the top decile of funds and startups and other assets that have an excellent track record of protecting and growing investing principal. And we do this at AUM fees that are 5x lower than traditional players.

    We currently bring you access high quality Private Equity Funds, Venture Capital Funds, and Pre-IPO startups. Create a login in 2 minutes to check out the available opportunities.

    Why should you care as an investor for private markets?

    Better Returns and lower volatility

    In multiple articles that follow on this blog as well as my LinkedIn profile, I will demonstrate how returns in PE/VC/Pre-IPO opportunities are calculated and why they make sense. For now, I will borrow from Bloomberg and Goldman Sachs to illustrate the point. They looked at overlapping data for hedge funds, private equity and real estate 1990 to September 2017. A traditional 60/40 portfolio of U.S. stocks and bonds — as measured by the S&P 500 Index and the Bloomberg Barclays U.S. Aggregate Bond Index — returned 8.2 percent annually during that period, including dividends.

    Adding a 10 percent allocation to each of the three alternative investments — as represented by the HFRI Fund Weighted Composite Index, the Cambridge Associates US Private Equity Index and NCREIF Fund Index Open-End Diversified Core Equity, respectively — would have added 0.7 percentage points a year. And thanks to hedge funds’ ability to short stocks and the fact that private assets aren’t subject to the whims of public markets, adding alternatives would also have resulted in smaller declines during each of the last two bear markets.

    Check out our upcoming article on Pre-IPO funds and their past returns. Some of the numbers surprised even us.

    Our promise

    We built this platform to create a differentiated experience, and that is what we are going to provide. As investors, you can be assured of:

    • We will never recommend an investment that we would not put our own money in. None of our team members have a revenue or fee income target, the only target they have is to make sure that we protect our investors’ faith at all costs
    • We will not push products, we will put the facts in front of you as transparently possible, and answer your queries as needed. But ultimate investments decision remains with you.
    • Because of point (2) above, unlike every other fund out there we do not charge any fees on committed capital. You pay when you invest and start earning. Or else you pay nothing.
    • We will not build hidden fees in asset prices. All fees are transparent and upfront. We would rather see you walk away than feel cheated at any point of our interaction

    And it begins!

    The word Torre means tower, or watchtower in Spanish. While you progress in your careers, we will make sure your money works as hard as you do, and that is always protected in the best manner possible.

    Reach out to me at [email protected] 24*7 and I guarantee a response within 24 hours (not working hours!). As we work to expand and better our offering for your investing pleasure, please feel free to send across your feedback and comments.

     

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