PUBLIC VS. PRIVATE

Late-stage private tech companies are now essentially their own asset class

Obsession
Future of Finance
Obsession
Future of Finance

The number and value of late-stage private tech companies has soared in recent years, transforming the group into its own new asset class.

There are now 471 such companies, up from 171 in 2014, and their total value is $490 billion, reports Peter Christiansen, the research director at Scenic Advisement, a private Silicon Valley investment bank.

“Private is not distinct as it once was from public,” Christiansen said in an interview. “The private market is starting to look like a proper asset class.”

Of course, public markets have a few big differences from private ones. Some tech companies listed on public stock exchanges are massive compared to their private counterparts: Apple’s $761 billion market cap dwarfs its closest private startup rival, Uber, which is valued at $68 billion. And private companies disclose little of the information public companies must reveal under government rules.

And then there’s liquidity. Every year, more than $77.5 trillion in stocks are transacted on the world’s exchanges, while Scenic estimates 1 that the tradable portion of the market in private, late-stage startup shares is about $35 billion, up from $11 billion in 2012, though precise measures are difficult. Since only a limited amount of those shares changes hands through direct private equity transactions, the private (or secondary) market is often composed of founders, employers, and early investors selling stocks to deep-pocketed institutional investors.

But the size and types of private companies is starting to converge with their public counterparts. To measure this, Christiansen created an index profiling the characteristics of private, independent companies that have raised at least $75 million in venture backing in three or more formal financing rounds in the US or Europe, which is how he defines late-stage companies. Data were drawn from Pitchbook and Bloomberg, as well as Scenic’s involvement in private transactions.

The index of 471 companies identified by this measure shows that the top 10 private firms, valued at a median of $10.7 billion, are similar in value to those in the S&P Mid-cap 400 index, and substantially more than those in small-cap funds. For example, Airbnb’s $25 billion valuation approaches the market cap of the 88-year-old hotelier Marriott around $39 billion.

A similar pattern is seen in the sector distribution of companies. Although internet companies are far more concentrated in the private index, the trend in other sectors is moving toward those seen in in public markets, which Christiansen called a sign of pre-IPO companies evolving into a proper asset class.

 

Two forces are likely behind this evolution. First, technology companies are inserting themselves into almost every aspect of our lives. In 2017, five of the world’s six largest companies were in technology, up from zero in 2010.

The second reason is the ability to raise vast sums of money once only available via initial public offerings to push off the date of their IPOs. The average age of technology firms at IPO has risen (pdf) from around around five to eight years in 2000 to about 11 years today. In Silicon Valley, fewer companies are raising bigger rounds than anytime in recent history, reports Pitchbook and the National Venture Capital Association.

There are more ways than ever for investors with enough cash to grab a piece of the pie. Brokers now run formal secondary offerings before an IPO is on the horizon, allowing companies, employees, and investors to sell shares in small, discrete tranches, usually to institutional, wealthy individuals or late-stage venture investors. On the retail side, SharesPost pools individual investors money to invest in funds that back a portfolio of vetted startups.

Yet casually treating such investments as a distinct asset class might not be the best move, says Olav Sorenson, a management professor at the Yale School of Management. Its value is likely correlated with public stocks traded on market exchanges. “Does private equity, for example, really behave differently from publicly-traded equity (other than being harder to buy and sell)?” Sorenson wrote by email. “Probably not that much. Some investors, therefore, would not consider private equity a separate asset class.”

But he said patient investors with enough cash could diversify against company-specific risks and build a diversified startup portfolio with higher expected returns, so long as they were comfortable with limited opportunities to sell.

Correction: A previous version of this post stated the incorrect date of hiring for Olav Sorenson.

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