Private Investment Farce

Peter Katevatis - Sep 12, 2019
Private company investing might seem low risk but you must beware the unicorn. WeWork is an example of the true test of value.

There is a beautiful exclusivity to private company financings that makes investors feel all warm and fuzzy inside.  Investors are offered the privilege to give their money to a dynamic growing company with little say on how the company is run.  Everything is managed by high quality professionals and you are told the risk is very low.  Terms like “unicorn” are added to the sector to further solidify investor’s demand and feelings of being special.

 

KWM Wealth Management - Unicorn

 

The reality of private company investing is that it is not all rainbows and horned horses, it is speculative investing.  If any investment offers high returns, it is high risk.  There is no magic formula or strategy that gives an investor the fantastical aura of 10x returns without a high degree of risk.

 

There has been a proliferation of private investments that claim low volatility.  While the stock market gyrates with 2-3% intraday swings, the purveyors of private investments claim 0% volatility as the investment sits on your statement at $10/share.  The reality is that the stock market is an instantaneous valuation mechanism that is constantly changing with every earnings release, interest rate deviation, or presidential tweet.  The public stock market may seem crazy at times, but it gives you an instant snapshot of reality which sometimes leaves us feeling nervous.

 

It’s ok to feel nervous when things are not going your way, reality can do that sometimes.  Your portfolio should be constructed in a way to make you feel confident you can weather the occasional storm as you proceed to your long-term goal.  I feel that private investment valuations give investors a false sense of security and can create investment behaviours that vary greatly from reality.  Here is an illustrative example of a private company timeline and valuation:

 

Founders build a business spending $250,000 of their own money to bring their idea into fruition.

  • Issue 2,000,000 shares at a deemed value of $1.00 (Valuation $2,000,000)

Raise money from family & friends ($300,000) to grow marketing campaign and boost sales

  • Issue 200,000 shares at $1.50 (Valuation $3,300,000)

Raise money from venture capitalists ($1,000,000) who want a piece of the action, Series A round

  • Issue 200,000 shares at $5.00 (Valuation $12,000,000)

Expand ownership to private wealth funds looking to deploy capital ($10,000,000) in growth companies, Series B round

  • Issue 1,000,000 shares at $10.00 (Valuation $34,000,000 - 3,400,000 shares at $10)

In this example, the business raised $11,550,000 but was able to show growth to $34 million, rewarding shareholders.  Everyone feels good but these are simply numbers on paper.  The true test of value is what you can sell something at, not what you think it’s worth.

 

As of this writing, WeWork is still a private company.  They raised money in January 2019 at a valuation of $47 billion.  Now they are considering going public but the valuation range is a more humbling $15-20 billion.  Quite often private investments are built on hopes and dreams of future riches, reality is another story.

 

Reality, often the scourge of most dreams.