The world of equity can broadly be divided into public and private markets. The public markets are open to the general population, with investors buying and selling shares of stocks on exchanges like the New York Stock Exchange (NYSE), NASDAQ and the Singapore Exchange (SGX). In the private markets, a much smaller pool of accredited and institutional investors acquire equity in private companies in exchange for the funding they need to grow.
Private Equity Means Earlier Access To Fast Growing Companies
As a rule, investing in the private markets comes with higher rewards (and higher risk). By the time a company goes public, a large portion of the upside (AKA its potential to increase in value) has already disappeared (along with much of the risk). While investors still stand to gain at this point, the earliest (private) investors will already have earned vast returns. Yet there are trade-offs.
Consider the example of Uber. Like many startups, Uber obtained its seed money by offering equity to angel investors. One such angel, Mike Walsh, put down a mere US$5,000 in 2010. When Uber went public in May 2019, Walsh’s share of the company was worth nearly US$25 million, a 5000x (500,000%) return on investment (ROI), or about 550x per year. By contrast, an individual who bought US$5,000 of Uber shares on the day of its initial public offering (IPO), would, a year later, own shares worth approximately US$3,800, for an ROI of about -25%.
The private equity sector outperformed the public markets by most measures over the past decade, but this is not to say that private equity is a guaranteed winner. This fact is illustrated by the experience of angel investors, who sit at the ‘ground floor’ of the private markets where the risks and rewards are the most extreme, and where deals have traditionally only been available to a tiny pool of connected individuals. In Uber’s case, Mike Walsh was one of just 11 angels, all of whom came from the tight-knit Silicon Valley tech community, and all of whom invested in what was, at the time, little more than an idea. While Walsh may have had conviction in Uber and the core team behind it, the reality of angel investing is that most investments fail and most angels don’t have access to companies like Uber. Therefore, angels often adhere to an investment philosophy where rare homeruns compensate for repeated strikeouts. This means angels typically outlay millions of dollars before finally getting a big payout.
Private Markets Are Traditionally Defined By Lack of Liquidity
Another important consideration for those investing in the private equity markets is the lack of liquidity. Unlike public markets, where shares of listed companies can reliably be bought and sold near-instantly, private markets have traditionally been far less liquid. Mike Walsh, for instance, had to wait fully nine years before he could convert his investment back to cash. By contrast, anyone buying Uber shares on the public market today can of course instantly sell them.
After angel investing, venture capital is considered the next level off the ground floor in the private markets. It is still highly risky and extremely exclusive, with venture capital firms consisting of a small group of partners who pool their money and share the profits. Venture capital firms usually invest in private companies that are in their high growth stage. In Uber’s case, venture capital firm Benchmark Capital invested US$12 million for an 11% stake in Uber in 2011. At IPO, that stake was worth US$7 billion, for a 583x (58,300%) ROI, or about 73x per year. Traditional venture capital still faces the liquidity problem though, so investors at this stage must also have a long timeframe and high conviction.
Moving Up The Chain
After venture capital, private equity (PE) firms and investment banks typically account for the next waves of private equity funding. Here, access to investments is slightly democratised but still decidedly exclusive. PE firms (well-known players in the space are Bain Capital and the Carlyle Group) raise a large pool of capital from affluent investors, then use it to invest in established companies or buy them outright. Investment banks structure their offerings similarly, and the best funds pay out between 8-20% per year.
Continuing with our Uber example, Tata Capital, an India-based PE firm, invested US$100 million in Uber in 2015 through its Opportunities Fund in exchange for an undisclosed amount of equity. The Opportunities Fund was raised in 2013 with commitments of ~US$600 million from a select list of marquee global investors. The fund deploys between US$30 – 100 million per deal with a timeframe of four to seven years.
Access to PE Firms Still Highly Exclusive
The minimum capital required to invest in PE funds varies by firm and fund, but US$250,000 has traditionally been the lower limit and some funds carry minimums measured in the millions. Institutional investors here may include insurance companies, pension funds and sovereign wealth funds. Individual investors must be ‘accredited’, meaning they meet high net worth value (HNWV) thresholds defined by regulatory bodies. In the case of Singapore, for instance, to reach accredited status, an individual must earn a minimum of S$300,000/year.
The Bottom Line: Private Equity Offers High Potential Returns (At A Cost)
With ground-floor access to companies in their high-growth stage, the private equity markets offer investors a much higher potential ROI. Yet the long investment time frame (lack of liquidity) and high minimum capital requirements lead to exclusivity in the sector, meaning the best PE deals have traditionally only been available to a tiny subset of the population.
How does iSTOX democratise access to private equity?
iSTOX is an investments platform that lowers the barriers to entry to private markets and alternative assets while addressing many of its traditional issues, such as lack of liquidity and transparency. Investors can start with as little as S$1,000 in opportunities that traditionally require millions to enter. It is also the world’s very first regulated platform that offers issuance, settlement, custody, and secondary trading of digitised securities. It is based in Singapore and is open to all non-US accredited investors and institutional investors.
Singapore-based iSTOX is the world’s first integrated platform for digitised securities. Regulated by the Monetary Authority of Singapore (MAS), iSTOX uses proprietary technology to directly connect buyers and sellers. In so doing, iSTOX provides accredited investors with access to previously out-of-reach investment opportunities, including private equity, hedge funds, private debt and more. To sign up for the latest news about the company, technology and more, connect with us on Twitter here, LinkedIn here or Facebook here. Or subscribe to the iSTOX newsletter here.