Investing, The Private Way
Johan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Who doesn't want to invest in Twitter, Dropbox or Spotify?
It can be difficult to invest in a company that doesn't trade on an exchange, but there are opportunities for investors to play the game.
Investing in private companies is restricted to what are known as accredited investors. These individuals (or married couples) must have a net worth of at least $1 million, or income of at least $200,000 for the past two years ($300,000 for couples), with a reasonable expectation of making the same amount in the upcoming year.
The government assumes that people who have more money are more sophisticated, although of course that isn't necessarily the case. Even for sophisticated investors, the risks involved in this type of investing are significant. Private companies don t have to make the same regular disclosures of key information that public companies do in annual and quarterly reports, making it difficult to evaluate their financial health.
The Dodd-Frank financial reform legislation narrowed the pool of such investors by prohibiting them from using their primary residence in determining their net worth. With their home equity excluded, fewer people are eligible for the most straightforward types of private-company investing.
Things are changing! With the JOBS Act, signed by President Obama last year, the nature of early-stage funding will change dramatically. But for now investors still have to look for alternative ways to invest in private companies.
Retail investors can buy shares of publicly traded companies, from giants such as Blackstone Group (NYSE: BX), or Fortress Investment Group (NYSE: FIG). Both are heavily involved in the private equity business, but I don't see them investing in companies such as Twitter, Spotify or Dropbox.
Blackstone is a leading manager of alternative assets and a provider of financial advisory services. The firm's main business involves the management of private equity funds, real estate funds, funds of hedge funds, credit-oriented funds, separately managed accounts, and closed-end mutual funds. Blackstone also provides corporate advisory services, merger and acquisitions advisory services, restructuring and reorganization advisory services, and fund placement services.
Blackstone runs one of the largest real estate opportunity funds in the world. Real estate funds offered by alternative asset managers like Blackstone will have a difficult time matching up against real estate investment trusts, given their significantly higher fee rates, lack of liquidity, and lack of transparency inherent in their operations.
Fortress Investment Grou
Fortress runs private equity and hedge funds for institutional investors and wealthy individuals. The firm's private equity funds are focused on control-oriented investments, real estate properties, and debt securities. Fortress' hedge fund offerings are comprised of liquid hedge funds, which invest in more liquid capital markets, as well as credit-driven private equity and hedge funds, which focus on distressed and undervalued assets.
I wouldn't recommend Fortress. Minority shareholders are exposed to all of the risks inherent in Fortress' operations, while reaping only a small amount of the returns generated by its funds. The company is subject to "high water mark" provisions on many of its hedge funds, which means that Fortress receives only performance fees when the fund's value is greater than its previous greatest value. Therefore, if a hedge fund experiences losses in a period, the firm will not be able to earn incentive income from that fund until it surpasses the previous high water mark.
The real money and undervaluation is within smaller players.
One of them with a broad portfolio of high-growth, venture-backed private companies is a firm called GSV Capital Corp. (NASDAQ: GSVC).
Structured as a non-diversified closed-end management investment company, GSV Capital has elected to be treated as a business development company under the Investment Company Act of 1940. GSV invests in emerging, high-growth private companies with the goal of providing growth-oriented investors a vehicle to participate in value creation happening in the private sector. The company is focused on the high-growth sectors in the economy, including Social Media, Mobile Computing, Cloud Computing, Green Technology, and Education Technology. In general, the asset management team will acquire the investment positions directly from employees and early VCs, as well as primary shares directly from the company and from the emerging private marketplaces.
The company has a broad portfolio of 44 holdings that includes names as Dropbox, Twitter, Violin Memory, as well as companies that went already public such as Facebook. Twitter remains GSV's largest holding at about 14% of the portfolio. This private security is extremely hard to purchase due to Twitter's strict internal policies concerning stock ownership.
For example, one of the porfolio's holdings, Dropbox, is a file hosting service that offers cloud storage, file synchronization, and client software. It allows users to create a special folder on each of their computers, which Dropbox then synchronizes so that it appears to be the same folder (with the same contents) regardless of which computer is used to view it. Files placed in this folder also are accessible through a website and mobile phone applications. The company is worth more than $4 billion according several sources.
Because of the unsuccessful Facebook IPO, the stock price of GSV has declined dramatically from $20 to $8.51 currently.
The current stock price doesn't reflect the underlying value (Net Asset Value as of Sept. 30, 2012) of $13.45.
Quarter four was more positive for some of the company's holding such as Facebook. Facebooks's portfolio value has increased with 45% since September 30, to a fair value of $10,027,500. Given the anticipated revenue growth in the portfolio companies and the potential liquidity event (IPO) for some of the portfolio's names, I think investors are to worried about the company's prospects going forward. Net Asset Value is much higher as of Dec. 31, 2012, leaving GSV Capital Corp. with an even higher undervaluation than before.
Right now FOOLISH investors can participate in high growth private companies with a clear discount to net asset value.
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