Unicorns, Donkeys, and Late Stage Valuations - Are You Managing Your Portfolio Well? (Part 1)

Atish Davda
Dec 3rd, 2015
Bob and Susan walk into a bar…

Growth Tech and Increasing Private Market Depth
Bob: “Fidelity marked down Snapchat’s valuation. I’m not sure how to invest in tech right now. Clearly, the bubble is bursting, the good times are over.”
Susan: “Whoa! Slow down. Take a deep breath. Let’s talk through this.”
Think About it 
If you follow the growth technology sector, it is understandable if you share Bob’s concerns. But, as his savvy friend Susan points out, remember to take a breath and make a well-reasoned decision that is right for you.

With technology companies staying private longer before their IPO, a lot of value previously created in public markets has shifted upstream into the private markets1. This structural shift in value creation has led to many private tech companies staying private longer in order to meet the higher bar set by public market investors2. Growth stage tech firms often operate at a loss in order to sustain those eye-popping levels of growth. Companies sustain these losses by raising capital from private market investors, who want to buy low (today) and sell high (years later).

The private market used to be like an exclusive country club, where only big-ticket investors were allowed entry. However, since the most recent wave of private secondary transactions starting in 2013 led by firms like EquityZen (marketplace for private investments – see disclaimer below), accredited investors as defined by the SEC, like Bob and Susan, can now play at the club3.

After years of speculation, the private market is showing its first signs of deceleration in the rise of private company valuations4. So, after years of steady paper gains, Bob and Susan’s investments are showing impacts of a typical market cycle – the rise and fall of asset values in line with macro-economic events.

The First Test
Bob: “But, Square IPO’d below the last round! Isn’t that the swan song for the industry?”
Susan: “Have you ever attended a wedding without a date?”
Bob: “Yes”
Susan: “Does that mean you will go to all weddings, parties, and dinners without one?”

While Bob and other early stage investors may recognize private investing as an asset class has high-risks and high-rewards, they may not be aware of hedging strategies they could implement. It is time to think about their private investments as part of a rapidly maturing industry, with greater options. How they respond to the first real test in the current market cycle will determine whether they feel welcome back at the country club.

Since investors new to the private market frequently consider “angel investing” to be synonymous with “private market investing,” a distinction highlighted in this Inc.com post, they assume traditional VC power law returns for their entire private market portfolio. That is, they spray investments into a lot of companies and pray some of them produce outsized returns.

The spray-and-pray approach leads investors to focus on maximizing-ROI on every investment. While the strategy may work for early stage investments, it is near-sighted if applied to the entire private market allocation of your portfolio. In fact, a better portfolio construction methodology within growth stage companies is to optimize for IRR rather than ROI. Put another way, it makes sense to look at the private market investments, which might include growth stage (as opposed to early-stage) technology firms, as a portfolio you should consider rebalancing.

This article is part one of a two-part series on investing in growth technology given concerns over late stage valuations. Click here to read part two, which covers common portfolio construction strategies Bob can employ…

Disclaimer: This article does not a) constitute investment, financial or tax advice, b) intend to purport an offer to engage into a securities or similar transaction, nor c) reflect the views of EquityZen. It represents simply my personal opinion.

3: Since these high reward investments, obviously come with high risks, only accredited investors are qualified to invest. Take a qualification test here to see whether you qualify as an accredited investor
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