The Shift of Risk to the Private Market


There are some landmark decisions that don’t get the necessary press coverage, until it’s too late and has unintended consequences. Earlier last week, the SEC voted to allow private issuers (like PE funds, VC funds,  and start-ups) to openly market their funds/companies. With this announcement, there are three points I’d like to address.

1.) This is huge for PE and VC firms, as much of the soliciting for funds currently has to be done in a somewhat of an “under-the-table” way. Today, for example, they can privately solicit for funds (via their contacts in the industry), but now they could theoretically put ads on the internet and on cabs if they wanted. The only news they can put out today is when they are finished raising funds and close their funding efforts. Much of the news that leaks is from the privately solicited suitors who talk to reporters in the industry. So, this ruling is huge for them, especially the smaller shops trying to attract new funds/investors outside of their rolodex.

2.) I don’t foresee this affecting start-ups trying to raise funds, the way it will affect PE/VC firms. One of the reasons things won’t change will be the intimacy of the fund-raising process. From a start-up’s perspective, the fund-raising process is very much a boy’s club. Either VC’s currently invested in the start-up introduce them to other suitable interested VC’s, or they seek out VC’s that have stellar talent and expertise in their wheelhouse. The audience is much smaller to begin with, so marketing won’t be as worthwhile. And I don’t foresee any change in investors in start-ups just because their allowed to advertise (like PE firms).

I will say though, Dropbox (the much anticipated file storing/sharing service) could change all of this. They are private, and probably will IPO in the next 12 to 18 months. They’ve already started to act like a publicly traded firm, holding earnings calls and the whole nine yards.

3.) The second phase of this vote, is to eventually remove the requirement that investors in private funds need to be accredited investors (over $1mm net worth and/or over $200k income per year). This will likely be removed soon…..

This is where the shift of investment to private markets will begin. Much of the risk is removed by the time start-ups go public (according to recent research), and there is little upside for the public markets. This is creating a big appetite for investing in start-ups (as well as direct exposure via VC funds), looking at the explosion of crowd-funding. With the shrinking supply in the markets (which are helping support current index levels), and risk being somewhat subdued due to the expansion of ETF and other funds, investors looking to make take on extra risk for extra return will begin delving into these markets. Let’s just hope they’re educated enough to know how risky these investments are (look up the Webster definition of venture). As they say in the  VC industry, if you have 15 investments, you hope that one, maybe two, are home runs and will ultimately make up your returns.

So draw up your doomsday scenarios now. This decision will without a doubt broaden investors investment choices, but could come with unintended consequences if investors aren’t properly educated before “venture” investing.

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