Stock and Bond Markets Dethroned: Private Fundraising Is Now Dominant

https://www.wsj.com/articles/stock-and-bond-markets-dethroned-private-fundraising-is-now-dominant-1522683249

124 109 8 years ago

fricat1ve2• 8 years ago

Another step along the path to public markets becoming essentially a suckers' game to siphon money away from passive investors.

Those who possess actual money seem to understand that real investments come with terms and conditions. Not just "Here's 10% of my salary, see you again when I retire."

tspike• 8 years ago

Could you explain how this would work in practice? If I'm allocating a percentage of my salary to, for example, Vanguard's total stock market index, how would that get siphoned?

empath75• 8 years ago

If everyone is just doing passive investment, there's no real price discovery, it's just valuable companies getting more valuable just because they're already valuable. It also screws with management incentives for the companies when their 'owners' are completely checked out and uninterested in performance.

charlesdm2• 8 years ago

One simplified example: say people are investing in a passive property fund. Those funds generally yield around 3 to 5% per year.

You're a smart entrepreneur. You build a huge skyscraper for $200m. You manage to generate a yield of 10% on that $200m. Most of the $200m is debt levered against the asset. The building subsequently gets sold to the fund on a yield basis. They'll pay $400m, i.e. $20m in yield p/a = 5%.

Smart entrepreneur just made $200m.

xivzgrev• 8 years ago

Kind of a disvirtuous cycle isnt it? More income inequality means fewer people have more money. If you need to fundraise it would be preferable to raise from fewer than more - lower transaction costs and oversight. These private individuals then capture more and more of the growth becoming further enriched.

At some point though it seems like it would backfire. If wealth is sufficiently concentrated than those individuals could effectively dictate terms, possibly even colluding with others. Then the pendulum swings back the other way, it may be more cost effective to go to public markets as crazy as that sounds.

Or maybe we just need a few huge flame outs to cause private investors to retreat.

jmalicki• 8 years ago

By disvirtuous do you vicious, or something else?

csense• 8 years ago

It's a tough problem. In the late 1990's, there was a big wave of accounting scandals (Enron, Worldcom, etc.) Which led to heavy regulation (the Sarbanes-Oxley Act). The Act was a well-intentioned attempt to protect retail investors from crooks.

The problem's that compliance is so burdensome and expensive that firms don't want to enter the public markets until they're already large (or if they're forced to when their cap tables get too big).

So this regulation that's supposed to help protect retail investors ended up hurting them by putting growth opportunities out of their reach. If you keep the regulations in place, it makes it easier for the rich to get richer and the poor to stay poor, deepening the class divide. But if you roll back the regulations, maybe the crooks will immediately see that as another opportunity to line their pockets by creative accounting, and in another few years we'll see a bunch of big companies go bust, as the lies can't last forever if the money simply isn't there.

Damned if you do, damned if you don't.

JumpCrisscross7• 8 years ago

compliance is so burdensome and expensive that firms don't want to enter the public markets

There's something bigger going on than SOX. That was the hypothesis the JOBS Act was predicated on [1]. Yet the trend continues uninterrupted.

My hypothesis: broadly held (i.e. by employees) companies taking long-term technology risks are fundamentally new. Moreso than reporting requirements, minute-by-minute pricing isn't helpful to a company challenging accepted wisdom over long time horizons. (Contrast: Tesla and SpaceX.) Being able to time large-scale valuation changes with technological milestones is a huge advantage no amount of public deregulation will compete with.

The trade-off between valuation control on one hand and liquidity on the other hand has multiple solutions. Deep private markets have an equilibrium between closely-held private businesses (e.g. Koch Industries) and widely-held public companies (e.g. Apple). (Multi-tier voting in public companies, as Snap and Facebook have, on the the other hand, seems untenable.)

[1] https://www.sec.gov/spotlight/jobs-act.shtml

jbob2000• 8 years ago

This is a false dichotomy. Just because the regulations we imposed in the past made things burdensome, doesn't mean that regulations we impose in the future have to be burdensome.

I'd want to understand why they're burdensome. Give me some concrete examples. Everybody talks about how regulations are burdensome but nobody actually mentions the specific things that are a burden.

ehmish• 8 years ago

You're required by to set up systems to ensure accounting information can not be tampered with, even if people tampering with accounting information isn't considered to be a high risk. To make it more concrete, it means you can't push to master any more in a git repository to fix some botched merge because, it happens to deal with revenue in some tiny corner of it's functionality and every change has to be approved by multiple people

commandlinefan• 8 years ago

I've never dealt with SOX compliance personally, but I did deal with PCI compliance. Now, PCI compliance isn't government-mandated, but since the penalty for non-compliance is that they take away your ability to take credit cards, it's treated as though it were a government mandate in a corporate setting. My observation about PCI compliance was the regulations themselves were clear, helpful, and well thought out. The burden was the months upon months spent arguing about who interpreted which regulation which way (and God forbid you just ask the regulators!), and an apparently certifiably insane executive board that would rather spend $1000 avoiding each individual regulation than spend $10 adhering to it.

avar2• 8 years ago

I don't know if this is true, but if it is wouldn't there be a really obvious pattern of the market value of initial IPOs going up compared to before SOX was passed? Is there such a telltale pattern?

andrewtbham• 8 years ago

It is true

https://www.vox.com/2014/6/26/5837638/the-ipo-is-dying-marc-...

Retric• 8 years ago

This has less to do with Sarbanes-Oxley than you might think. The real shift is how much money is chasing very low returns. When 4% over inflation starts looking great companies don't need to go public to access billions in capital.

KKKKkkkk1• 8 years ago

I doubt that investing in early-stage unicorns is the best way for the poor to get out of poverty.

throwaway2041• 8 years ago

No, but more folks in the middle class might be able to remain in the middle class if their modest portfolios had access to high-growth companies, ideally through index funds rather than individually-picked stocks

pjc502• 8 years ago

hurting them by putting growth opportunities out of their reach.

You're asserting that the "alpha" of the private opportunities is higher, even after you've accounted for risk. This should be amenable to statistical evidence? Including all the VC-funded duds and collapsed buyouts like Toys R Us.

I'm not sure that retail investors want this kind of risk profile; it seems to me that the demand is phrased in terms of interest rates. And to get back to higher interest rates we'd need more inflationary pressure from growth - which we don't have.

sol_remmy• 8 years ago

Thank goodness the government protects me, a non-accredited investor, from investing in any private companies! I'm too stupid to make investment decisions without going broke!

https://passiveincomemd.com/not-secret-society-accredited-in...

JumpCrisscross7• 8 years ago

I used to be skeptical of accredited investor requirements [1] until cryptocurrencies happened. That an entire space can (a) go from zero to fraud in the blink of an eye and (b) not only ignore the delineation between gambles and core investments, but develop a collective disdain for it and anyone espousing it, has me convinced of the rule's wisdom.

Investing in start-ups costs money. Diligence costs money, negotiating terms costs money and staying up to date on corporate actions costs time, and when it matters, more money. Those who can't afford that not only sets themselves up to get screwed, they bring down the quality of the ecosystem.

There is no person (a) who doesn't meet the accredited investor requirement and (b) for whom an illiquid, volatile security like start-up equity is a prudent risk-reward decision.

[1] https://www.sec.gov/files/ib_accreditedinvestors.pdf

nordsieck• 8 years ago

There is no person (a) who doesn't meet the accredited investor requirement and (b) for whom an illiquid, volatile security like start-up equity is a prudent risk-reward decision.

You say this as if its obvious, but I'm not even convinced that it's true.

Sure, there are all sorts of strategies that VC firms employ to mitigate their downside, but those are only marginally effective. The real reason the successful ones are successful is because they were part of the right deals, not because they lost less money on the wrong ones.

Modern portfolio theory is adequate protection from that kind of risk.

conanbatt15• 8 years ago

If the state used that argument, it wouldnt be able to run lotteries.

It is, as many other measures, used by some to profit at the expense of others. Investors have their competition blocked, and ignorant. If a company had the opportunity to go public a lot earlier, they would gain massive leverage over the traditional investors, which means better terms and cheaper money.

Cryptocurrency showed precisely the opposite: it showed the tremendous pent-up demand for investments that regulations forbid. And the best way to reduce fraud is to increase competition. Who wants to invest in cryptokitties when the other startup has actuall revenue and sales and asks for less money than the latest ICO?

Figure 100% of YC companies ICO'ing in comparison to what ICO's are today. It would be massive amounts of cash with al ot less strings attached.

nokcha2• 8 years ago

I think that the rich and the poor should have equal protection of the laws, as a matter of principle. Investor accreditation could be done on the basis of passing an exam (similar to how lawyers need to pass a bar exam in order to practice law) instead of on the basis of net wealth or annual income.

There is no person (a) who doesn't meet the accredited investor requirement and (b) for whom an illiquid, volatile security like start-up equity is a prudent risk-reward decision.

I disagree. I don't meet the wealth or income requirements for 'accredited investor' status, but if I had been allowed to invest some money in early-stage tech start-ups, I could have done quite well for myself.

mattnewport2• 8 years ago

Another interpretation is that the crypto mania is evidence of huge unmet demand for the types of investment profile that are largely unavailable to non accredited investors. If regular investors had access to more (possibly less risky) such investments perhaps the demand for crypto investments wouldn't have been so great.

SkyMarshal2• 8 years ago

There is no person (a) who doesn't meet the accredited investor requirement and (b) for whom an illiquid, volatile security like start-up equity is a prudent risk-reward decision.

I used to think this too until I saw a bunch of teenagers invest their allowance and part-time job money into a new industry that was open to them and get rich.

It made me wonder if perhaps the definition of accredited investor should be expanded to people who have not only a lot of capital but also lot of time till retirement, since there's an equivalency, and who can afford to take risks and make mistakes in their 20s b/c they still have time to make up for it later.

wslh• 8 years ago

I assume you are in favor of closing Las Vegas and prohibiting all those marketing campaigns that play with the brains and sentiment of billions of people. Many different kind of scams or tricks are present everyday.

Also, there are zillions of entrepreneurs wasting their health and time following impossible dreams. I prefer losing money than my health.

I am not endorsing any ICO but education should change to include basic finances since elementary school.

psyc2• 8 years ago

Often this argument isn't really about whether everyone is collectively 'better off' by some particular metric. It's about how much of a nanny state it takes to get that result, and whether that's contrary to the spirit of freedom of association. In other words, money is not the only value. Liberty itself is a value.

MR4D6• 8 years ago

Your last statement is incorrect. If it were true, then only millionaires would be able to start companies.

You’ve (inadvertently, I believe) just prohibited every independent plumber, carpenter, computer programmer, etc., from starting their own business. Because, trust me, starting a business is very illiquid - it’s like having a hole in your pocket.

Even worse, said plumber, carpenter, etc., has a high concentration risk - pretty much everything in one basket, including the person’s income.

maerF0x03• 8 years ago

I've long thought about a law whereby companies over some 409a valuation must allow public trading of their stock. For example maybe all companies over $5B or some other quite large valuation would be required to allow public sale of stock.

This would be good for much of society. It gives liquidity to employees, it creates a market forces valuation, it allows pensions and other institutions to more accurately index the economy as a whole.

What are some downsides I'm missing?

leojg• 8 years ago

Public companies tend to focus on making money instead of innovation?

They become slaves of their quarter reports and lose the ability of investing in long term projects?

Maybe a bit exaggerated? :D

dlp211• 8 years ago

I think shareholder expectations determine what a company does. If the company is a growth company, shareholders will gladly allow the company to innovate, but if it's a blue chip, they will expect dividends.

RussianCow• 8 years ago

What are some downsides I'm missing?

Maybe forcing owners to give up equity in their business just because their valuation hit some magic number? Keep in mind that not all $5B companies are Silicon Valley, VC-funded startups, and some founders still retain the majority (or in rare cases 100%) of their equity.

I also think you're over-exaggerating the benefits. None of those things seem like problems that need fixing.

FeepingCreature• 8 years ago

This wouldn't per se force owners to give up equity, it'd merely prevent them from making it available to a limited circle of investors.

conanbatt15• 8 years ago

Going public is super expensive. Are you saying the state should pay companies to go public?

maerF0x03• 8 years ago

yeah its hard to say... I would imagine most companies could create new stock to sale in order to cover the costs? I was mostly thinking about creating liquidity for those who want to sell existing stock, more than raising from sale of new stock .

kaycebasques• 8 years ago

How expensive?

MR4D6• 8 years ago

Hers’s One complication:

Assume I start a business. I own 100% of it. It grows like crazy, and 5 years later, it’s worth $5 billion. Now you require me to go through all the regulatory hoops so that my stock can trade publicly. But nobody will buy my stock. Because there is only one owner, and he ain’t selling.

Simplistic, I know, but problems very similar to this actually exist.

maxxxxx• 8 years ago

It's just another symptom of increasing inequality. There is now enough private money floating around so there is no need for taking money from the general public. The main purpose of an IPO is to dump the stock on retail investors once valuation isn't increasing anymore.

dmoy• 8 years ago

Say one has enough income or assets to be an accredited investor, but doesn't want to spend the time to figure out what private market investments are worthwhile. Do there exist any low fee broad market index funds for that?

gibybo• 8 years ago

EquityZen has an index fund of sorts, but the fees are high and it only includes companies that are on EquityZen which are probably not representative of the average.

I'm not sure how much you need to join a round with a VC fund (and they would distribute that into a bunch of companies for you), but that might be your second best bet.

patentatt7• 8 years ago

Lol, if you have enough to be an LP with a VC, they’ll find you ;-)

rdlecler12• 8 years ago

Public markets are highly efficient and it’s difficult to have a real sustainable advantage. Private markets are different. Access to deal flow is king and there is no insider trading because not everyone has the right to invest in any company they want. This concentrates returns in a handful of king makers.

rdlecler12• 8 years ago

One issue is even with accredited investors is the so-called 99 investor problem for pooled investment vehicles. If I’m a company I don’t want thousands of individual shareholders on my captable. The answer would be that we could have crowdfunded VC funds that invests. But because the SEC limits pooled investment vehicles to 99 accredited investors you limit the number of $1k-$100k checks you can take in, which then limits how big a crowdfunded VC could be.

MR4D6• 8 years ago

Qualified Purchasers ($5MM+) are limited to 500, thereby minimizing this problem considerably.

There are other ways around this that are surprisingly obvious to those who work in the industry (but virtually unknown to outsiders)

advisedwang• 8 years ago

Available at http://archive.is/efiAd

Stock and Bond Markets Dethroned: Private Fundraising Is Now Dominant

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