There are around 20,000 public companies and more than 2 million private companies in the U. S..
There is no reason to assume that the economics of investing in private companies should be different from that of investing in public companies. As all investors seek to maximize returns and minimize risks, private company investors have a different investment agenda. While public stock holders invest to maximize returns for a specific holding period at a specific risk tolerance, private company investors pay more attention on the ending share values either in its IPO or being taken out by another private suitors. Their time horizon, usually longer, is between 3 to 5 years. As a result, private shareholders should be expected and tolerate the significantly higher volatility in their share values before the payoff dates.
Private shares, by design, have higher values than otherwise public shares for the reasons of high entrepreneurial returns and avoiding public monitoring and scrutiny costs. Routinely, private owners resist the liquidity benefit of going public so their returns will not be diluted by the public capital markets. This is the reason why Uber has consistently refused to go public. Virtually all venture capitalists and private equity funds have stood in line to fund Uber’s $15 billion round. This is the reason why Snapchat can raise $2.6 billion practically overnight.
Every one of us would have loved to be one of the original private shareholders of $380 billion Facebook, $37 billion Instagram, and $55 billion PayPal. Of course, every one of us would have loved to be one of today’s private shareholders of $68 billion Uber, $20 billion Snapchat, and $33 billion Publix.
Of course, we wish we were the private shareholders of the $46 million Green Mountain Coffee Roaster (formerly NYSE: GMCR) before their IPO in 1993, as well as their pubic shareholders of $14 billion GMCR right before they were taken out with an 80% premium in 2015.
It is more interesting, though, to look at the commonalities of these enormous successes so you can say “I wish I had known ….” All of them possess some sort of uniqueness in their business models, including creating a disruptive or an interruptive technology, revolutionizing “the way we do everyday things,” inventing a brand new culture, or creating and serving a new niche market.
Of course, those privileges are only historically reserved to the families, friends, famed, and riches. With the advent of the internet, retail investors can access the secondary markets of private shares on several online exchanges, such as SecondMarket or SharesPost. Even though the liquidity and the tradeability of private shares, by definition, are limited, there has been over $20 billion in transactions a year, nearly 40 times the secondly volume a decade ago.
However, buyers beware that there is a natural “adverse selection” on the quality of trading of private shares on the secondary markets. The private companies, who offer new shares online, must have not had the interest from the venture capitalists or private equity community who would have done a tremendous amount of due diligence on the offering. For those insiders, employees, or previous private equity backers who want to “cash out” their shares online, it is hard for you not to ask, “Why sell?” or “Why now?”
Do you really want to be on the other side of these trades?