The Growth of Investing in Early-Stage Companies by Accredited Investors: What to Know and How to Participate

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Everyday, early-stage company investing continues to become more accessible to accredited investors. There are two primary reasons for this. 

The first, is that investors are demanding access. 

Public markets and real estate seem overheated, bonds are yielding negative rates of return after inflation and banks are paying zero interest. Venture capital and early-stage investment continue to grow in popularity. Celebrity founders now garner pop culture interest. There is a wave of capital and investment occurring in the private company space that those with capital to deploy want to participate in.  

The second reason is that technological advancement and regulatory reform have responded to this demand. Together, they are bringing private company investment opportunities to more and more individuals everyday.

Within this article, I will discuss the primary reasons that accredited investors look to place capital in early-stage companies and how these opportunities have evolved in recent years. I will show how the market for private company investment has recently evolved and will likely continue to do so at an accelerated pace. To conclude, I will provide guidance as to what investors should consider when making direct investments into private companies and how they can participate in this golden age of private investment.

Why Should Accredited Investors Invest in Early-Stage, Private Deals?

  1. Early-stage company investing has the potential to earn outsized financial returns

It is no secret that investing in earlier stage companies has the potential to earn significantly outsized returns as compared to investing in later-stage, more-developed companies.  

Many readers have heard the success stories of the likes of Uber. Uber underwent it’s seed round of funding in 2010 at a company valuation of $5.4 million.  When it went public in May 2019, the valuation was set at $84.2 billion. That represents more than a 15,000x increase in value during the 10-year period following Uber’s seed funding round. Similarly, Lyft seed investors experienced about a 10,000x return when the company went public in March 2019.  

Of course, not all early-stage investments will perform like Uber or Lyft, and investors should not necessarily expect them to. Rather, these are drastic examples that are meant to demonstrate that buying into exciting companies at an early stage, and more importantly at a significantly lowered valuation, is a time-tested methodology with the potential to earn significantly enhanced returns if investors choose their placements successfully.  

How many investors who wait for companies to go public before they invest in them have any hope of even a fraction of this level of returns?

  1. Surprising to some, there are actually more opportunities in private markets than public markets

To contrast from a macro-economic viewpoint, investors should be aware of the inherent limitations that exist of investing purely in public companies.  An excellent review of the market was completed recently by Hamilton Lane, which provides you with a number of insights as to why investors should be looking to private market investment in lieu of public markets.  

One glaring statistic was that there are currently only 2,600 public companies with annual revenues of more than $100 million, compared with 17,000 private businesses of that same size.  This statistic means that accredited investors allocating capital solely to public equities are limiting exposure of their investable assets to just 15% of the largest companies and firms in the U.S.  

Private markets represent a much wider diversity of businesses, and aren’t limited to the large cap titans that dominate the American public markets today.  Often these smaller, private companies are more dynamic and innovative. Their potential for multiples on invested capital is simply much higher.

  1. The number of public company investment options is actually decreasing

Of additional stress to public markets, the number of public companies is actually constantly decreasing. The number of public companies has shrunk from 7,810 at the beginning of 2000 to only 4,814 at the end of 2020. For investors allocating via a public-equity-only model or to solely public index funds, investors have less companies to place capital into every year and their investments that are made touch only a portion of the real economy that exists today.

  1. Private company investment outperforms public market investing

In addition to the macro-economic factors expressed above, private company investing has significantly outperformed public market investing in recent years. According to the Hamilton Lane research cited above, over the last three years private equity has generated a premium of 38% over public equities.  

But likely of more importance to you as an investor is the consistency of outperformance over a longer timeline. Look at this statistic – private equity and private credit have each outperformed global public equity and credit markets, respectively, in 19 of the last 20 years.  Within the chart below, you can see the significant outperformance of private equity vs. other asset classes in recent years.

Source

There Are More Private Company Investment Opportunities Open Than Ever Before

We are in the golden age of private company investing for accredited investors.  A confluence of events has made it easier for accredited investors to access private market investment opportunities than ever before.   

  1. Raising capital and investing in private companies has become simpler

More opportunities exist to invest in private companies because the process for companies looking to raise capital has simplified legally and practically. Easier for companies means more opportunity for investors.  

The combination of (1) more legal options for raising money, (2) the loosening of how companies can market private investments to accredited investors and (3) some rational amendments to the rules around who can participate in private company offerings, has led to many more opportunities for investors to participate in private company deals. 

Crowdfunding up to $5 million is now an option: Only in the past few years have crowdfunding platforms where viable deals (not the left-overs) can be seen become more of an active player in the early-stage company investing world.  Since the SEC´s reform to increase the crowdfunding limit for companies from $1 million to $5 million in a given capital raise in 2020, crowdfunding has become a more viable source of funding for successful companies to raise capital.  In the past, the $1 million limitation created an infeasible amount of work to justify for companies who were on their path to truly growing successful businesses. What could they really achieve with only $1 million?  With $5 million of potential capital at stake, more and more companies are looking at crowdfunding as an appropriate supplement to their existing capital raising plans.  

As such, the companies that are participating in the Reg CF space are improving to the delight of investors.  Frankly, prior to this year, crowdfunding was seen largely as a last resort and only companies with nowhere else to go would list their offerings on these platforms.  The growth in the sector is only expected to increase in the coming years.  The global crowdfunding industry is forecast to grow by $196.36 billion during 2021-2025. 

While not exclusive to accredited investors, crowdfunding expands the universe of investment opportunities available to accredited investors and increases the amount that they can place into each deal – they can take all $5 million available in any deal if they would like. This crowdfunding arena can be an interesting place for accredited investors to make capital placements in early-stage companies before these companies become the next big thing.

Ability of companies to advertise their deals to accredited investors: Only within the last decade have companies been able to publicly announce that they are raising capital without having to jump over a mountain of legal restrictions. Private investment in private companies was limited largely to company insiders or their direct circle. Those old rules are gone, and with more information now comes more opportunities for accredited investors.   

Accreditation is no longer simply a wealth-only test: The Securities and Exchange Commission (SEC) used to draw arbitrary lines of income and wealth to define those who could “fend for themselves” and thus could invest in private deals as the only real way for private individuals to be deemed accredited and thus eligible to invest.  This landscape is also changing.  There is more flexibility than ever before to become an accredited investor through professional qualifications and other relevant factors.  

  1. Technological advancements have made accessing private deals easier and more transparent than ever before

In recent years, the development of capital syndication platforms have been a prevalent advancement in the fintech world. We discussed the evolution of crowdfunding platforms above. Blockchain companies are also now getting involved. The model of both of these platforms is to pair companies raising capital with interested investors.

More and more fintech companies have been focusing on the use of blockchain to more accurately record shareholder transactions, set up a future platform for secondary market trading and create a more seamless investor experience, which we like.  These blockchain companies currently focus on larger company transactions and fund structures.

We at Legacy Group feel that blockchain technology and the securitization of private transactions and secondary trading is likely the future of private company investment.  Through our discussions with industry insiders, we should see significant movement in this market over the next 12 – 24 months and could start seeing the product portfolio expand to service mid-market and small-market transactions. 

As this movement occurs, we and others who are raising capital from accredited investors will continue to expand the technological capabilities of our own investment offerings to leverage these technological enhancements.   

How to Invest Wisely In Private Placements

As a result of these market developments, accredited investors will surely have more and more direct early-stage investment opportunities available to them going forward.  

While we are not going to advise you to invest in each and every opportunity the market offers, we do encourage you to take an active interest in the review of these private companies for your portfolio. As you make capital deployments into the best-of-the-best, these placements are likely to have the potential to greatly enhance your overall portfolio return as compared to staying with “traditional” investment methodologies, as we established above. 

These opportunities are likely to be coming at you in a number of ways that you previously haven’t thought about, such as Linkedin or Youtube, as these social media platforms have been proven to be very effective for private companies looking to syndicate capital from accredited investors.  

In our experience at Legacy Group, we also want to offer you the following advice based on what we have learned over the course of our own journey in direct early-stage company investing.

  • Investors should only make investments in companies they understand: The allure of huge tech exits or the excitement of creating an algorithm the world has never seen before is a rationale for certain accredited investors to enter the early-stage company investing space. I would caution you though that risk is an identifiable attribute to any portfolio investment and must be taken into account when making any capital placement.  While I would agree that risk tolerances, quantification of risk, etc. will vary by investor, I would also counter that statement with the fact that if the investor has zero understanding of an industry or can’t explain the business model that risk analysis is not effectively being completed.  I would encourage any investor who is looking to manage their own direct investment portfolio to fully understand the industries and the business they are investing into.  If the understanding is not there, the chance for a faulty investment increases exponentially.

  • Make concentrated placements into companies you believe will be the most successful:  In our own experience at Legacy Group, we have discussed the ideology of how to make direct placements in private companies with many of our high-net-worth clients.  While each ideology may deviate slightly depending on one’s goals, there is one strategy I would definitely not recommend to more sophisticated accredited investors.  That strategy is what I would call the “blind diversification” method pursuant to which the investor makes numerous, small placements in potentially 50+ companies per year and tries to “spread their bets” among a number of companies.  There are a few issues with this strategy. First, if your business or day job is not that of an investment analyst it would be very difficult to accurately diligence, and subsequently place capital into, 50+ portfolio companies. Second, and more importantly, which of these companies do you really believe has the most potential to be a great company?  One of the basic themes of early company investing is to fund companies that are going to be excellent companies in 5 – 10 years’ time. Not every company is going to get there.  I must agree with the wisdom of Charlie Munger when he says “The wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.” Diversification is a wealth protection – not wealth creation – strategy. 

  • Invest only into industries that you want to see succeed in the future, thinking long-term:  This may seem self-explanatory, but if a certain industry means something to you as an investor, it likely means something to other investors as well.  Given the call from investors for impact-focused companies in recent years, industries like sustainable energy and agriculture are taking off in a big way.  Many of our own investors in our Green Coffee Company, for example, make their investment decisions at least partially based on the fact that they love coffee and they want this industry to sustain itself into the future.  Many of the companies that will look to change the world, as well as earn greater profits for investors, will be focused on industries that matter to the most investors personally in order to secure funding to make those dreams a reality. Given the nature of early-stage company investing, a typical hold period for an investor is likely 5 – 10 years.  This means that investors should be thinking about the world that their portfolio is capable of creating a decade from now, not what value can be immediately extracted today.

Accredited Investors Should Leverage the Current Wave of Opportunity

The bold – those who do not take the “hand-it-over-to-my-broker” or “I’m banking on my 401(k)” approaches – have just an incredible amount of investment opportunity before them as we write this.  We encourage you to start or expand your journey in private company investing and participate in the next wave of world-changing companies. We are.  

About Legacy Group

Legacy Group is distinguished by a singular tradition of service to our portfolio partners; the mutual commitment to, and the seamless collaboration of, a true partnership; formidable financial and legal talent across multiple disciplines and jurisdictions; and shared professional values that focus on client needs.

We provide experience and investment to a wide range of private companies spanning many industries, including real estate, hospitality, tourism, agriculture and technology. Contact us to learn more and to discuss current investment opportunities available to you in our portfolio companies.

*This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. Any views expressed herein are those of the author(s) and not necessarily those of our clients.

Sources:

https://news.yahoo.com/raising-money-crowdfunding-used-last-103000202.html

https://www.hamiltonlane.com/en-US/Insight/0c9fc38d-a3b5-48dc-808a-5458e6332cc1/Broader-Horizons-The-Case-for-Private-Markets-Inve

https://www.wsj.com/articles/uber-jackpot-inside-one-of-the-greatest-startup-investments-of-all-time-11557496421

https://www.theinformation.com/articles/lyfts-biggest-ipo-winners

https://www.businesswire.com/news/home/20210611005202/en/Global-Crowdfunding-Market-Forecast-to-Grow-by-196.36-Billion-During-2021-2025—Blockchain-Technology-and-Niche-Crowdfunding-Platforms-Set-to-Lead-to-Sizable-Demand—ResearchAndMarkets.com

https://legacy-group.co/how-can-investors-choose-an-impact-investment-that-actually-makes-an-impact/

https://legacy-group.co/u-s-accredited-investors-rush-to-alternative-investments

https://www.sec.gov/smallbusiness/exemptofferings/regcrowdfunding

Jesus Reyes

Vice President, Capital Raising

Economist by trade, spent 15 years working for HSBC in a multitude of capacities in its Private Wealth, Credit Risk Management and Investment Banking divisions. Furthermore, Jesus worked for the bank in multiple countries. Prior to leaving HSBC, Jesus was the Global Account Owner of the bank’s relationship with the world’s largest accounting and consulting firms.


Upon leaving Wall Street, Jesus joined a boutique Medical Group in Beverly Hills, as CEO, with the primary goal of leading the team through a process of corporate transformation from a small enterprise to a corporation able to navigate the terrain of bringing in Private Investors and expand into new markets: New York, Orange County, Chicago and San Diego.


In addition to extensive professional experience, Jesus holds degrees in Economics (BA – St Mary’s University, and MA – Fordham University) and Finance (MS – University of Rochester).

DUSTIN BALDWIN

Vice President, Business Development

After multiple combat tours with the U.S. Marine Corps Reserves and obtaining a Bachelor’s Degree in Finance and Real Estate from the University of Florida, Dustin took a position in corporate finance with Lockheed Martin, followed shortly by obtaining his Series 7 and 66 certifications as a Financial Advisor at Edward Jones. Looking for an opportunity to implement his leadership earned in the Marine Corps and entrepreneurial desire, Dustin decided to leave the corporate environment and joined a family-owned private prisoner transportation start-up, while also investing in real estate. Over the next several years, Dustin became a partner in the company, moved into the role of Executive Director and helped grow the company through strategic relationships, winning large government contracts, and helping foster several mergers, ultimately getting the business to a successful sale. After obtaining his MBA in Real Estate from Florida State University in 2020, Dustin continued to invest in real estate, taking a specific interest in land acquisition and development to create equity and cash flow opportunities. Additionally, he was involved with several start-ups and became one of the largest investors in The Green Coffee Company, a Legacy Group portfolio company. After getting boots-on-the-ground with his Green Coffee Company investment in Colombia, Dustin saw an opportunity to become more than just a passive shareholder and joined Legacy Group as the VP of Business Development in June 2022.

 

Dustin has earned a reputation for his genuine leadership style, adaptive problem-solving skills, ability to forge authentic relationships, and being a fast-moving action-taker across multiple industries. His fluidity and adaptive results-oriented mindset makes Dustin an excellent addition to Legacy Group as our VP of Business Development.

 

Dustin lives in St. Petersburg, Florida with his wife Jenny and their German Shepherd, Kimber. Going on 18-years in the USMC, Dustin will retire after 20 years and continue to focus on adding value to Legacy Group Stakeholders.