The Tech Premium: Why Exposure to Early-Stage Technology is More Important Than Ever
If you can’t imagine life before toiletries were delivered in two days in neatly packed boxes, or the ride-sharing model of Uber, you aren’t alone. Innovative start-ups have, time and time again, advanced modern life and the ways that business is done. Once a new technology is adopted by the market, it changes society like a wildfire, creating new norms, new opportunities and new wealth.
The fact is, according to research out of the Kauffman Foundation, startup businesses — including much of the tech market — account for nearly all net new job creation in the U.S. and 20% of gross job creation, creating an average of 1.5 million jobs per year. And consumer tech alone both directly and indirectly supports 18.2 million jobs, provides $1.3 trillion in annual wages and represents roughly 12% of GDP, adding $2.3 trillion to the nation's economy every year.
Technology, and particularly early-stage tech, matters more than ever.
However, the relationship that investors have with the tech sector is different than it was as recently as 20 years ago.
Consider Amazon, which went public in 1997 priced at just $18 a share. If you had invested $1,000 in its IPO, your investment would be worth approximately $634,000 today.
Uber, however, hit the market in May 2019 at a price of $45, closing down 7.6% on its first day. Since then, it’s fallen much lower— trading just above $30 as of November 2019.
In other words, investing in companies after their IPO debut isn’t what it used to be. Companies are waiting longer than ever to go public and arriving on the market as more mature, established companies. The potential upside just isn’t there for public tech investors anymore like it used to be.
Investing in Early-Stage Tech
But smart investors are catching on. More than ever, dollars are moving to fund early-stage technology companies, rather than waiting for arrival on the public market after that opportunity is lost.
Here are a few reasons why exposure to early-stage tech companies is more important than ever.
Companies are waiting longer than ever to go public: Unlike their predecessors in the 1990s and early 2000s, many tech companies today are waiting to conduct an IPO, banking on the fact that remaining private gives them more flexibility and autonomy and that they can hold off on going public while investor money is available. According to the investment bank Scenic Advisement, private investors infused $130.9 billion into technology and biotech companies in 2018, far outpacing the $50.3 billion raised via IPOs and follow-on offerings. As a result, once they do finally hit the market, these tech companies are more like enterprise offerings than true, high-flying IPOs. It’s like Microsoft vs. an upstart like Facebook in the early days. There’s just more upside potential for investors in early-stage companies.
Money can be made well before an IPO: Early-stage tech companies have a model that works, but have yet to get that model to scale. Typically, early-stage tech companies have already officially launched their product and are focused on customer acquisition and generating cash flow. This makes early-stage investing different from and much safer than seed investing, which typically helps start-ups to develop their product or service.
They’re busy expanding their markets: Many private companies want to have a market clinched before their IPO, which means they are busy growing. The technologies that will be the most successful and will be most likely to create a new norm have the right “product/market fit.” According to one of the term’s pioneers, Eric Ries, the term product/market fit describes, “the moment when a startup finally finds a widespread set of customers that resonate with its product.” In other words, a product needs to have a market that’s ready for it in order to be successful, and it can find that before going public. (Think of the many people that used Uber before its public debut.)
Early-stage companies diversify a portfolio: Early-stage companies have only a minimal correlation with the broader market, and therefore investments in them aren’t subject to the same market fluctuations as publicly traded securities.
There are lower capital requirements: Previously, pre-IPO companies were only available to venture capitalists and major brokerage companies. But, because of mutual funds and new investment models, that’s no longer the case. At EquityZen, for example, we allow investors to get started with as little as $20,000. This enables investors who were previously excluded from pre-IPO private companies to invest in private companies on a high growth trajectory.
Disruption happens early-on: Technology companies are by definition disruptive. They exist to solve business problems in innovative ways. And, to the unseasoned investor seeking to invest before an IPO, every budding tech company with a good elevator pitch can sound like the next big thing. Instead of a limited approach, broad exposure to the full landscape of innovations is crucial in determining which ones are likely to create new norms.
Early-stage investing will yield the greatest returns: Simply put, if you want to see big returns, you don’t wait until a tech company hits the public market. To circle back to Uber: In 2010, a novice investor named Mike Walsh invested $10,000 in UberCab, now known as Uber. His $10,000 is now worth tens of millions of dollars. And, it was only his second investment ever. In other words, the stage at which investors get into a company with just a small investment and multiply it exponentially has shifted from post-IPO to pre-IPO.
Risk factors and early-state technology
However, it’s important to remember that, with the potential for great reward comes sometimes great risk. Investing in early-state technology carries with it an extra layer of risk when compared to investing in public assets such as stocks and bonds.
The first is liquidity risk. Since the early-state markets are smaller and less active, there is less liquidity in the market than in something like typical public equities. You may not always be able to find a buyer for shares you’re looking to sell, and this low level of activity can also lead to wild price fluctuations.
What’s more, the disruptive companies that participate in the early-stage tech market are volatile by nature. They are working on solving big problems and are placing large bets on world-changing technologies to do it. This opens up the potential for big gains, but also big losses. It’s not unheard of for companies at this stage to suddenly go out of business, leaving their investors with a total loss.
Successful investing means buying low and selling high. With companies arriving to the public market with sky-high valuations that they struggle to live up to, it’s a hard place to make the money that was possible 20 years ago. For investors seeking to see big returns then, early-stage tech companies are where today’s upside is happening.