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How Does Private Tech Fit in a Diversified Portfolio?

June 29, 2017

With public equities valued at all-time highs, where can wealth managers find attractive growth opportunities? One place is shares of late-stage, ventured-backed technology firms.

Shares in these high-growth, private companies can offer double- and triple-digit revenue growth rates – opportunities uncommon in publicly traded companies.

For RIAs, family offices, mutual funds and other institutional investors, the increasing number of successful companies in this category creates an opportunity to include private tech growth companies in a diversified portfolio for clients.

Today, the number of private companies considered unicorns – those late-stage, VC-backed firms valued at more than a $1 billion – exceeds 200, according to CB Insights. In terms of market valuation, the total value of these companies is almost $700 billion.

What’s more, significant amounts of capital continue to flow into the space.

In the past year, there have been many new primary rounds of funding for these companies, from $100 million to $500 million. Lyft’s $600 million round in early June and Sofi’s $500 million round in February are the latest examples.

The universe of private tech growth companies is expanding because firms are choosing to stay private longer.

Just a decade ago this cohort stayed private, on average, five or six years. The goal was to move quickly to an IPO to raise cash, generate liquidity and build creditability. With so much capital flowing to private tech growth companies now, there’s no rush to IPO. In fact, there are important reasons to put off a public listing as long as possible.

By remaining private, hyper growth companies benefit from operating without all the demands and requirements of being a publicly traded company. That means keeping their financial performance and other sensitive information confidential.

This creates a competitive advantage over public companies that must show their hand to the world every quarter. The private market’s relatively low regulatory burden also eliminates the need for costly time-consuming audits and reporting to the SEC. And, it insulates these firms from shareholder lawsuits.

On the risk-reward continuum, shares of these companies, which sit between growth equity and alternative investments, have significantly greater risk than publicly traded equities, fixed-income securities and cash. The trade-off is that they can produce outsized returns.

Private tech growth companies are less liquid by traditional standards. In that regard, shares of these companies are similar to other types of illiquid assets, such as real estate, private equity and early- and mid-stage, VC-backed companies.

Liquidity typically occurs through secondary market sales that bring together accredited and professional investors. Price discovery for shares of these companies is improving due to a growing and active secondary market. Investors no longer need to rely exclusively on primary round valuations. There is an increasingly liquid market for investors around the world.

Because the shares are less liquid, private company stock is less susceptible to event-driven volatility. Trading private stock requires the company’s approval, and that process can take anywhere from several weeks to a month or more. As a result, there is no day trading or program trading of these shares. The trading dynamics are different for private companies compared to publicly traded companies.

In other words, the stock of these companies tend to be independent of the performance of the other major asset types. When constructing an asset allocation strategy, exposure to these companies can produce more return with less risk for the entire portfolio.

For RIAs and family offices, exposure to late-stage, VC-backed shares is emerging as one more opportunity to build a diversified portfolio and realize potentially significant returns.