The Power of Innovation in Creating Value
Innovation has always been a driving force behind economic progress and the creation of wealth. It used to be that investors could only access the growth of revolutionary companies once they went public on the stock market.
However, the investment landscape has evolved significantly in recent years. Many companies are now delaying their initial public offerings (IPOs) and choosing to remain private for longer periods or indefinitely. The number of IPO transactions dropped from an average of 325 per year from 1980 to 2000 to a mere 135 since 2000.
To tap into the growth potential of innovative new companies, investors need to shift their focus to the private markets.
Unlocking Innovation in Private Markets
The public markets have undergone significant changes. Take Apple Computer as an example. When Apple went public in 1980, it raised $100 million on $117 million in revenue. By 1984, the company had generated $1.5 billion in revenue, providing public investors with substantial returns.
Today, the massive returns akin to those of Apple in the 1980s are rare in the current IPO environment. Early stage investors are now reaping the majority of the benefits from high-growth companies. This is where the true transformative opportunities lie.
Private market investors have traditionally supported early-stage, high-potential, fast-growth companies through venture equity. However, venture debt has emerged as a viable complement, offering another way for investors to participate in the innovation as an asset class. As new companies seek funding, venture debt provides a means to reduce capital costs and minimize ownership dilution, enabling investors to engage in the company’s future growth.
Ultra-high-net-worth individuals and family offices have recognized this opportunity, shifting their investment focus towards private transactions since the global financial crisis (GFC). Institutional investors have followed suit, with direct investment in private transactions rising by 175% in the US and 210% globally over the past 15 years.
In a major move, Blackstone announced a $2 billion investment in private technology loans, including venture debt, with BlackRock acquiring one of Europe’s largest private venture lenders. Stephan Caron, head of EMEA Private Debt at BlackRock, highlighted the appeal of private credit as an asset class due to its income generation, low volatility, diversification, and low default rates compared to public markets.
The potential benefits of private market investments, particularly venture equity and venture debt, contribute to five dimensions of performance.
Enhancing Portfolio Performance through Private Market Investments
Private market investments offer a range of benefits that can bolster portfolio performance:
1. Portfolio Diversification
Allocating funds to pre-IPO equity and debt instruments can enhance portfolio diversification by spreading risk across sectors, stages, and regions. Investments in early-stage companies can provide low correlations with traditional asset classes, improving risk-adjusted returns, especially as the number of publicly listed companies continues to decline.
2. Growth and Return Potential
Companies tend to experience rapid growth during their pre-IPO stages, offering substantial potential for value appreciation. Venture debt provides consistent annual income paired with returns from equity participation, with low loan loss rates across the industry over the past two decades.
US Private Equity and Venture Capital Index Returns*
| Index | Six Month | One Year | Three Years | Five Years | 10 Years | 15 Years | 20 Years | 25 Years |
| CA US Private Equity | –5.3% | 6.7% | 23% | 20.6% | 17.8% | 12.6% | 14.8% | 13.8% |
| Russell 2000 mPME | –23.5% | –25.6% | 3.9% | 5% | 10.2% | 7.1% | 8.6% | 7.9% |
| S&P 500 mPME | –20% | –10.9% | 10.5% | 11.2% | 13.5% | 8.9% | 9.4% | 8.3% |
| CA US Venture Capital | –13% | 2.7% | 30.5% | 25.7% | 19.3% | 13.6% | 11.8% | 28.1% |
| NASDAQ Composite mPME | –29.3% | –23.5% | 13.1% | 14.1% | 16.2% | 11.6% | 12% | 10.4% |
3. Early Access
Investing in start-ups provides an opportunity to get involved in high-growth companies at an early stage, securing more favorable terms and potential higher returns. By investing in fledgling companies with lower valuations and higher growth prospects, investors can tap into the success stories of industry disruptors like Uber, Airbnb, and SpaceX.
Early investors in Uber turned a $510,000 investment into over $2.5 billion, while Airbnb’s early backers saw a $260 million investment grow to $4.8 billion. SpaceX investors are also poised for significant gains, with recent valuations reaching $137 billion.
4. Unveiling New Ideas
Investing in venture equity and debt funds, along with start-ups, provides insights into emerging trends and technologies, offering a broader understanding of market dynamics and evolution. Private markets present a wealth of untapped innovation and informational advantages, with reporting still less standardized than in public markets.
The private market offers investors direct insights from the companies shaping the future, providing a unique perspective that can inform investment decisions.
5. Exploring Niche Markets
Private firms often address niche and underserved markets that larger competitors overlook. By investing in specialized start-ups, investors gain exposure to unexplored markets and their growth potential.
The evolving investment landscape highlights the critical role private market investments play in enhancing portfolios. Beyond diversification, these investments can offer improved risk-adjusted returns and access to exponential growth opportunities.
As the public equity markets face challenges in delivering outsized returns, investors must turn towards venture equity and venture debt to capitalize on innovation and economic progress.
Stay tuned for future discussions on venture equity and venture debt investments in upcoming installments of this series.
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The views expressed in this post are the author’s opinion and should not be construed as investment advice. They do not necessarily reflect the views of CFA Institute