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How to Hedge Against Private Company Valuations

ShareholderInvestorSecondary MarketInvesting Strategy

Atish Davda   January 05, 2017

"How can I hedge against private company valuations?"
"Can I short pre-IPO shares?"
"How do I lock my shares’ current price?"

I often get variations of these questions. The answer is "no" – but, I usually point out other ways to enhance the private market portfolio. I thought EquityZen’s client base might find them interesting, so below are some ideas. If you have ideas on the matter, please send them my way via a comment or email.

Before we dive in, the ‘needless to say’ must be said: this post should not be construed as advice of any manner, and investors seeking advice should consult their financial, tax, and other advisors. Investments made through EquityZen are investments made in a pooled investment fund which acquires shares in specific pre-IPO companies. As with investments generally, there is a risk of loss; for instance, there is no guarantee that a pre-IPO company in an EquityZen fund will conduct an IPO or lead to a profitable exit for investors. Past performance is not predictive of future returns.

If you have a bearish outlook on a public company’s stock, you can usually short sell shares in that company. While short selling, or shorting, is a risky strategy, it can be a valuable tool to enhance portfolio returns if your negative outlook on the company turns out to be a good bet.

In private markets, you cannot short sell shares. But, that doesn’t mean you cannot optimize your portfolio in other ways. Below are a few ideas you might consider.


I hear investors bragging about multiples, or return on investment (ROI), they achieved with certain exits (EquityZen is guilty of calculating these multiples as well, by way of our Path to IPO series). As an investor managing your portfolio, set aside chasing the multiples and focus on portfolio optimization. Remember, while some investors have a phenomenal track record of winners, most people usually simply brag about outliers in their portfolio.

In venture investments, which tend to perform on a power law,[1] it might be better to optimize for internal rate of return (IRR) rather than ROI. Put another way, if possible, it makes sense to sell a portion of holdings in a given name to lock in return. These shareholders can then consider diversifying with new investments, including, if they qualify, EquityZen’s own investment opportunities.[2]

Portfolio Rebalancing is In

There is a misconception that selling any private stock at all is equivalent to a loss of confidence in the investment. Consider that myth busted.

Even for those who question all seller motives, there is a difference between seller motives based on circumstances: consider a 20-year veteran executive at a public firm selling their stake and an early employee seeking liquidity to pay off student loans.

After all, could you imagine if you couldn't rebalance your portfolio in public markets for a decade?

Diversify Across Sub-Sectors

The early-stage VC industry invests in sub-sector trends, which change from time to time. Just to highlight some examples: a decade ago, the social media (e.g. Facebook, Twitter) trend was followed by daily deals (e.g. Groupon, LivingSocial). More recently, bitcoin (e.g. Coinbase, BitPay) has come and receded from popularity, to be replaced by the sharing economy (e.g. Lyft, Airbnb). Today, it seems virtual reality and augmented reality, known as VR/AR, are fashionable.[3]

Some of these seed stage companies may graduate to become late-stage private or even public companies over time. While the daily deals sector rose and collapsed, the social media sub-sector still has its fair share of behemoths.[4]

Spreading investments across sectors in which you have conviction can help diversify your portfolio against idiosyncratic risk (e.g. when bitcoin collapsed following Silk Road seizures).[5]

Back Backers

Certain pedigreed venture capital firms have delivered impressive returns.[6] These VCs attract entrepreneurs who want to be affiliated with a strong VC brand, and therefore have access to greater deal flow. While past performance is never an indication of future returns, in the VC industry, it is a little more auto-correlated than with public market investors.

Invest in Value

Many "angel investors" limit themselves to early investments. In fact, while absolute returns are stronger from investments in break-out companies, growth equity investors (typically series C and beyond) tend to produce stronger returns.

We have seen early-mid stage VCs raise growth funds in the past few years, not only to capitalize on follow on investments, but also to balance out their portfolio.[7]

Some Other Posts We Have Written that May Be of Value

With much discussion of sky-high late stage valuations and a dry well of IPOs in 2015-2016,[8] our Knowledge Center hosts a section of insightful articles under Bubble Talk. Please help yourself as you think of ways to manage your portfolio in the venture-backed market.

Please share your thoughts on the matter below via a comment or contact me.

Disclaimer: This article is not investment or tax advice, please consult your investment or tax advisor. Investments made through the EquityZen platform are investments into pooled investment vehicles, which then acquire shares in specific pre-IPO companies. Investments through EquityZen are speculative, illiquid, and carry a high degree of risk, including total loss of investment.

[1] https://equityzen.com/blog/late-stage-valuations-unicorns-managing-your-portfolio/
[2] See disclaimer at end.
[3] https://www.cbinsights.com/industry-analytics
[4] Twitter’s recent criticisms aside, it is still commands a $12B market capitalization. http://finance.yahoo.com/quote/twtr
[5] http://www.coindesk.com/us-government-to-sell-44000-btc-in-final-silk-road-auction/
[6] http://www.wsj.com/articles/andreessen-horowitzs-returns-trail-venture-capital-elite-1472722381
[7] https://www.cbinsights.com/blog/billion-dollar-exit-venture-capital/
[8] http://www.feld.com/archives/2014/06/the-opportunity-growth-fund-trend.html
[9] http://www.nytimes.com/2016/04/02/business/dealbook/tech-start-ups-choose-to-stay-private-in-ipo-standoff.html

Selling in Private Secondary Markets

ShareholderInvestorSecondary MarketPre-IPO

Sean Troy   May 19, 2016

Imagine that it is July 31st, 2015 and you are an investor who just purchased $1 million of Valeant Pharmaceuticals (VRX) stock.  Fast-forward May 17, 2016.  That $1 million investment would have plummeted in value to $123,416.  If you had instead chosen to invest $1 million in XLV, the S&P healthcare ETF, you would have $905,471.  Not necessarily a positive return in value. But not a complete wipe out of it either.

It is easy to see how diversification can dramatically increase both the return and diminish the risk of a portfolio.  The massive influx of capital into ETFs in recent years (global ETF assets now exceed $3 trillion) is certainly evidence of the value that investors place on diversification.  Yes, this is partially driven by cheaper fees, but it can also be attributed to the inherent diversification implied in the underlying ETF.

Public market investors diversify their holdings for down-side protection or to rebalance their portfolio.  By buying and selling certain assets, investors can maintain their desired level of asset allocation and effectively manage their risk exposure.  These are not only common, but encouraged, diversification tools in public markets.  Yet, in private markets, the selling of private company securities is often stigmatized.  Why the disconnect?

This misguided sentiment has largely been driven by the admittedly inflated value of so-called “unicorns”, startup tech companies valued at over $1 billion.  Fidelity Investments reportedly cut the valuation of many of the startups that it holds a position in earlier this spring.  This well-publicized development has led many to believe that private market selling equates to a lack of confidence in the companies themselves.  Sure, there is truth that the value of many startups has become magnified, but it is important to not let temporary news diminish the real value and long-term benefit of private market investment diversification and portfolio rebalancing.

The reasons why an investor might want to sell/rebalance their investments in private companies are very similar to why that same investor might sell their public market holdings.  If a hedge fund trader had invested exclusively in large-cap oil producers 20 months ago, that investor would have lost about 35% of his net worth.  Meanwhile, investing in SPY, the S&P 500 ETF, would have yielded a small profit over the same investment horizon.  For the exact same reason, it is equally imperative for private market tech investors to diversify their holdings across subsectors, including hardware, cloud, IOT, etc.  Diversification is not limited to startup specialty.  Investing across funding stage, firm size, and geographic focus can also protect a private stock investor from downside portfolio risk.

And let’s not forget about simply mitigating exposure to a company’s idiosyncratic risk.  As we saw earlier with our VRX example, let’s consider an investor who held a significant amount of their equity in Theranos, the privately held medical laboratory services company that now finds itself at the forefront of a regulatory probe.  During the summer of 2014, Theranos was valued at roughly $9 billion.  Now, after Federal investigations into the company, the seemingly invincible startup could be worth zero.

It’s naïve to assume that any company, public or private, is immune from a dramatic drop in value.  But an investor holding 5% of its portfolio in Theranos equity would be far less nervous about their wealth than an investor with, say, 70% exposure.  That same investor would also be far less likely to be scrambling to find the limited buyers willing to purchase the illiquid asset of Theranos equity.  While the value of any company can go to zero, hedging yourself against that risk through portfolio rebalancing is imperative.

As the startup landscape evolves and companies specialize in new technologies, it will be important for investors to have accessible capital to deploy to new ventures.  To obtain that capital, a private stock investor may have to sell an existing holding.  A desire to invest in a new startup certainly should not be an indictment of another company.  This is especially true if the startup that the investor is selling to generate capital has justifiably increased in value.  If a large mutual fund sells a significant portion of a holding in a public stock that has doubled in value, the decision isn’t perceived as a denunciation on the value of the company. Instead, the fund is lauded by investors for locking in a profit.  Similar praise should be given to private market investors.

The good news is that there are a variety of platforms through which investors can liquidate a portion of their private stock holdings.  Private secondary market platforms such as EquityZen, connect shareholders of startup companies with investors looking for access to late-stage companies before IPO stage.  Access to such platforms will continue to provide private market investors with the ability to sell their holdings to ensure that their portfolios are structured in a way that minimizes their risk.  

Profiling the Average Tech Company at IPO

ShareholderInvestorStartupsSecondary MarketUnicorns
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Alex Wang   April 13, 2016

In August 2015, we published  “But When Will They Go Public? A Profile of the Average Company at IPO”, in which we analyzed 71 venture-backed tech companies that went public in the US between January 2013 and June 2015. As a result, we arrived at the profile below of a “typical” tech company at IPO:
Exhibit: A typical tech company at IPO

Source: Capital IQ, CrunchBase, Company S-1s, EquityZen
Unfortunately 2015 was not a great year for tech IPOs--in fact it was the worst year since the Financial Crisis, with only 28 technology companies entering the US public markets. Have things changed since July 2015, when we last crunched the numbers? In this post, we analyze the 11 (that’s right, just 11) information technology companies that have gone public in the US since July 2015.

Your Typical Tech IPO

Average time to IPO remains unchanged. This cohort of companies took 11.4 years on average since inception to go public, which is almost the same with our previous analysis. However, high variability comes with this much smaller sample group: it took the youngest company, Square, six years to go public; whereas for First Data Corporation it took 26 years. 

Company and offering sizes were similar as well. On average, the LTM revenue of these companies was $1.06B, with a net profit margin of -6%. Their average gross offering was $413 million, 2.2 times of companies that went public between January 2013 and June 2015. However, taking out the largest offering from First Data ($2.6B gross offering), then the average drops to $198M, similar to our previous analysis. Without First Data, the group’s average revenue becomes $388M, very close to the previous group.

Seven of the eleven companies analyzed have fundraising data in CrunchBase, and they’ve raised on average $212M in equity funding before going public. The average last round before IPO was $75M, slightly higher than the $63M in our previous analysis.

So what do these tell us? A typical tech company at IPO looks pretty much the same in the past three years.

So, Have These Newcomers Returned Similar Rewards to Investors?

Similar to our previous analysis, most companies in this period managed to return between 0-1x premium back to their last private round investors (based on 8 companies in this set that have reported private round pricings). Two smaller companies, Mimecast and Adesto Technologies were able to return 4x- 5x premiums, whereas Square went through a much discussed down-round. The average premium of these companies was 1.25x, much lower than the previous 1.90x. Arguably, IPO price correction has begun.

Exhibit: Offer Price Premium over Last Private Round- # of Companies

Source: Capital IQ, VC Experts, EquityZen

These newly minted public companies expectably have high volatilities in stock prices. Unfortunately, they haven’t been able to beat the market, or the overall tech sector yet. As shown in the chart below, since Jan 4, 2016, overall S&P, S&P Information Technology, and Nasdaq- 100 Technology Sector Indices all have went up slightly between 1.7% to 2.7% as of April 12, whereas the newcomers’ prices dropped by almost 13% weighted by market cap.

Exhibit: Stock Return Comparison (Jan 4, 2016 price as baseline) 
Source: Capital IQ
And where are these companies trading at now? On average a 4.18x price-to-sales ratio. It is higher than S&P 500’s 1.8x and Nasdaq’s 3.1x, but much shy of that of Facebook, Google, and Microsoft.
Exhibit: Market Cap/LTM Revenue (PS) Ratios
*As of April 12, 2016
Source: Capital IQ, EquityZen

What Now?

Although based on a much smaller sample size, a typical tech company at its IPO still looks pretty much the same, and private investors are still able to get positive returns in most scenarios. However, the market has become much more conscious over these newly public tech companies, as the premium between offer price to last private round pricing is shrinking, the stock prices are highly volatile and suffering negative returns, and the price-to-sales ratios are humble in comparison with tech elephants. These data points confirm what we've observed anecdotally-- public markets, despite recent recovery, remain jittery about tech IPOs, and it is likely that the first few tech companies to make the leap may have to go public in an "IPO down round".

We believe the current market conditions present risks, but also bring opportunities. Private shareholders may consider liquidating to avoid a longer hold-up, whereas investors may be able to extract more value through investing in pre-IPO stocks now. Please refer to The Pre-IPO Investment Opportunity in a Down Market and A Down Market: When Liquidity Matters for our previous detailed analyses.

I’d love to hear your thoughts. Please comment below.

Data sourced from 11 technology companies that executed an initial public offering from July 2015 until March 2016 in the US (two Chinese companies also went public in the US in this period, but are excluded due to lack of data). Data retrieved from Capital IQ, company S-1s, and Yahoo Finance. Past performance is not indicative of future returns, and this is not an investment recommendation. Links to outside sources do not constitute an approval or endorsement of the content on those websites.