Nick Dignam from Fortitude Investment Partners shares insights with Lachlan Maddock from Fortitude Investment Partners on how a diversified portfolio in mid-market private equity is structured. The Inside Adviser
The world of alternative investments is at a crossroads. As markets defy expectations and liquidity concerns take centre stage, investors find themselves forced to rethink how they deploy capital in an increasingly complex environment.
Are stock markets rejecting venture capital valuations?
Venture capital has been one of the most popular and profitable sectors in which to operate and invest in the last few years. Traditionally, and ultimately still, the primary domain of the ultra-wealthy, pension funds and statutory investors, the sector has delivered returns exceeding 20 per cent a year for many years now.
Private equity and venture capital exposures have been among the top contributors to performance of some of Australia’s top performing industry super funds. For those with limited experience in the sector, private equity simply refers to investing into companies that are private, rather than listed on publicly available exchanges like the Australian Securities Exchange (ASX) or New York Stock Exchange (NYSE).
Venture capital gets a little deeper, in that it is also private companies, but tilted towards new companies or those in “start-up” phase. That is, these companies tend to have significantly higher risk and, in many cases, the vast majority will not generate any profits and may not even exist in a few years’ time. Canva is a classic domestic example that began as a start-up but has grown into a $40 billion-plus valuation as a private business, based on its funding rounds.
One of the biggest benefits of private investing is that there is less volatility in valuations; in fact, in most cases, the valuation is simply taken to be the value of the business when it last raised capital. The benefit of this is the time it affords management to prove a business model without having to worry about daily share price movements.
Venture capital and private equity companies have been among the most popular source of new IPOs in recent years (for example AirBNB or Rivian), but many of these newer arrivals have faced significant selling pressure as the Nasdaq and most technology companies’ valuations tanked to begin 2022.
According to Maximillian Friedrich of ARK Invest, a specialist in the fast-growing, listed technology sector, “one-third of companies that went public through IPOs during the past four years are trading below their previous private valuations.” That is, their share prices and market capitalisations on the publicly listed market are lower than the last time they raised money privately, which could be a few years ago.Â
Friedrich’s and ARK’s view is that “these data suggest that public market investors are rejecting late-stage and IPO valuations set by venture capitalists and investment bankers.” One prime example is WeWork, which was valued at US$104 billion in 2019 but after finally listing in 2022, is presently worth just US$4.5 billion.
The result is what he describes as a juxtaposition of “record private equity valuations against the severe valuation compression of early-stage public companies in the innovation space during the past year.” This is backed by recent data from PitchBook, which showed that flows into venture capital funds hit multiple records in 2021 including a doubling of investment to US$330 billion, and a jump in non-traditional VC investors entering the market in the pursuit of returns.
