Private Equity - Deal or No Deal?
Last month, a company named WeWork withdrew its filing to sell shares to the investing public (known as an Initial Public Offering, or IPO). Once valued as high as $47 billion, some investors are now seeking a valuation closer to $10 billion. The WeWork debacle can serve as a useful tool to illustrate both the role private equity plays in capital markets, as well as show both the heights and depths private equity returns can reach. Because some clients have already inquired about making private equity investments part of their investment portfolio, and others no doubt are curious, let's explore the concept a bit more this month. To begin, it's important to understand the nature and process of private investments. Once a company is started it (typically) needs additional capital to fund things like equipment purchases, advertising, and labor. Over time, the company approaches investors in what are called "funding rounds." Generally, these opportunities are reserved for the wealthy, or what are called "High Net Worth" or sometimes, "Accredited," investors. One relatively common definition is an indvidual who possesses more than $1,000,000 of liquid assets. The hope is that the valuation ascribed to the company increases with each subsequent round of funding. For most companies, the ultimate goal is to sell shares to the general investing public in an IPO. At that point, original investors hope to sell their shares at profits of 1000s of percent (or more)! Of course, the probability of all this happening is quite small. Most private equity investments go to zero, never reaching IPO, and leaving investors with a total loss. Clients sometimes ask me about making private equity investments and whether it's a good idea. Who wouldn't want to invest in the next Microsoft, Amazon, or Google at the earliest stages? Some have even already been approached by individuals looking for investments themselves. So, is investing in private equity a good idea? In short, maybe. But before we delve into that more, I want to share that in the last year or two, I'm finding myself more frequently being approached by brokers looking for access to my clients and their money. Sadly, it's not uncommon to encounter a broker that has no background whatsoever in financial services - no education, and no experience. Instead, they are lured to the position with promises of making large commission checks on money they bring to a firm. I'm also seeing more "late round" deals. This means the valuation has already been marked up multiple times. And while it could still be a great investment, in the case of WeWork, we've now seen those late round investors take a "paper loss" of almost 80%. And WeWork is not alone, in the last year, many of the most highly touted IPOs have seen their share price drop below the price it came public at. Increasingly, I'm viewing these investment offerings as predatory. Early in my career, I had the opportunity to work on a few private equity offerings. In the initial discussion, we asked a standard 115 questions. One hundred and fifteen! Answers came back to us in binders 100s of pages long. Research would go on for 8-12 hrs/day, five days/week, for multiple weeks, by multiple people. Instead of offering patience and time to make a good decision, I'm now seeing some of these offerings demand funds be transferred within a few days, another huge red flag. All-in-all, I can't help but scrunch my nose at what private equity has become the last few years. While some are pushing to make private equity more accessible to lower wealth individuals, I can't help but think this may be a "sold to you" deal where the little guy, in this case middle class investors, get left holding the bag on worthless companies they never really understood in the first place. For this reason, I encourage caution when it comes to private equity. While there are certainly good deals still out there and millions to be made, understand you have to sort through a lot of "no's," and invest a significant amount of time, before you get to that magical "yes." If you're interested in discussing further, let's talk about it.