Early Investing

Public vs. Private Shares? It’s No Contest

Public vs. Private Shares? It’s No Contest
By Andy Gordon
Date April 8, 2020

I’m glad I’m not my neighbor Kyle. He fled the stock market a few months into the Great Recession, sometime in early 2008, he tells me. And he never returned.

That was 12 years ago. During that period, I’ve had three jobs… married off two children… visited 13 countries… and made a nice pile of money (sorry, Kyle) in various public and private stock investments.

Kyle says he never invested in stocks again because the recently departed bull market was never “real” enough for him.

It was a big, glaring, OMG-sized missed opportunity.

But what’s obvious in hindsight isn’t so obvious in real time.

There’s no better example of that than what’s going on right now.

The United States is almost certainly in a recession. So are Europe and other major economies, including Canada, Japan, South Korea, Singapore, Brazil, Argentina and Mexico. China, the world’s second-largest economy, is expected to grow by only 2% this year, according to research firm TS Lombard.

These are extraordinarily challenging times. And for most people, it’s hard to determine where – and when – to invest. So much depends on knowing when the pandemic will abate and when the economy will recover. And nobody has figured that out.

One of the hardest things to do is watch the value of your stocks go down and down. It takes a toll emotionally and psychologically. Many people are fleeing the stock market, and you can understand why. But that doesn’t mean it’s right.

I know what I’m doing. I’m buying shares. And I’m giving preference to markets that…

  1. Sell at a significant discount
  2. Boast high-quality opportunities
  3. Have more upside now than they’ve had in a very long time
  4. Avoid the immediate risk of falling prices
  5. Have an estimated 10% more risk than a year ago but have potential gains of 500% or more.

Based on these criteria, the private (startup) markets will provide more opportunities than the public (stock) markets.

Big Discounts Now Available

Public stock markets have fallen 12% to 20%. I expect shares of early-stage startups to also drop by about 20% to 40%. Shoppers love sales. But investors treat them with suspicion bordering on contempt. Even with all the uncertainty, the one thing we know for sure is that shares will once again go up. Now is the time to buy low.

High-Quality Deals

The great public companies of a month ago are still great and will thrive again. As for private startups, I’ve seen no diminution of quality in March going into April. Startups may be raising at lower valuations (which is good for investors)… may be giving themselves more time to raise… and may be expecting to raise less… but they’re still raising in numbers similar to before the pandemic hit. And the quality of crowdfunding deals has been getting better and better over the past year. The availability of high-quality startup deals remains outstanding.

Buying Upside

The upside for investing in great companies like Apple is much better now than before, thanks to lower price points. But even with an improved upside, public stocks can’t compete with the upside of startups. Apple might give you 50% to 100% gains over the next decade. But today’s startups have a much higher ceiling. The next Apple – or the next great artificial intelligence, robotics or biome company – should give you 10 times the gains Apple might give you over the next 10 years.

The Risk of Prices Falling Further

If you don’t want to watch your stocks plunge in value again, startups offer a reprieve that the public markets can’t provide.

Unlike public shares, the private shares of startups are mostly illiquid. Only a tiny fraction of these shares are sold on various secondary markets. That means the overwhelming majority of these shares are shielded from the millions of buyers and sellers who push the price of public stocks up and down on a daily basis.

The price you pay now for startup shares remains constant until the company raises again and receives a new valuation from its lead investors. Most startups give themselves one to two years between raises. By the time startups now looking for capital raise again, the pandemic should be over and the economy should be coming out of recession. Valuations will be on the rise.

An Enhanced Risk-Reward Equation

There is always risk in investing – especially in startups. The majority of startups fail. The odds are not in your favor. The onus is squarely on the investor to choose carefully.

If you invest in the strongest startups with the best leadership and most disruptive technology, you’re tilting the odds much more in your favor.

But even smart investors are facing greater risks now than they were before the coronavirus. I estimate that there’s 10% more risk than before. My biggest concern is that more startups are raising less than they want and shortening the time to the next raise. They’re going to have to generate more revenue in a shorter period and with a tighter budget.

But remember that the vast majority of startups are used to dealing with tight budgets. And most are constantly pushing to generate revenue sooner than later. This is nothing new. But the degree of difficulty is going to be raised a notch or two.

Now for the good news…

Early investors will be well compensated for the slightly increased risk they’re assuming by those startups that grow and reach successful exits. Let’s do some quick math. Let’s say a startup is worth $1 million when you invest and exits at a $10 million valuation. That’s a 10X or 900% gain. Now let’s take that same startup with a 40% discounted price, thanks to the current situation. Its valuation is $600,000. Your gains increase to 16.6X, or 1,567%. You’re making an additional 667% by taking on the somewhat greater risk.

So while it’s a buying opportunity for the public markets, it’s a much better opportunity for the private startup markets. I’ve told my neighbor this. And now you know.

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