We are going to change subjects a little bit today and discuss unicorns instead of financial independence. Now by unicorn I don’t mean the mythical horse-like creature with a horn on its head, I mean the startup companies, which are usually in the technology industry, and reach billion dollar valuations in just a few short years.
Back in 1997 a little company known as Amazon was looking for some capital and was ready to expand. So they did what every other company did when it got to this point, it tapped the public equity markets. It had an IPO (initial public offering) and raised $54 million, and after its IPO its valuation grew to $438 million. IPOs give a company capital through selling equity shares, which they use to invest back into the company, and also give shareholders of the company an easy way to “cash-out” and liquidate their investments, and at (hopefully) a decent price. When 99.99% of your net worth is tied up in a tech company you founded, it may be a good idea to sell at least a few shares to diversify a little, wouldn’t you think?
Let’s fast forward to December of 2015. Amazon now has a market cap of $315 billion (yes billion with a “b”). What this means is if you invested $10,000 in Amazon’s IPO in 1997, you would have approximately $4.4 million today (according to Business Insider). For the many index investors in this community, this type of unicorn is a great thing. By investing in total stock market index funds we unfortunately invest in some companies which go bankrupt (luckily the most you can lose is your investment), but at the same time we’re able to ride these unicorns which appreciate our original investment exponentially and in essence wipe out the losses of the companies which go belly up.
But something structurally has changed in the past few years in the way which companies seek to raise capital. Unicorns today don’t act like Amazon. A couple unicorns that come to mind are Uber which has a current valuation of over $50 billion and Airbnb which has a current valuation over $25 billion. Unlike Amazon, we have been unable to ride these unicorns since they didn’t seek our money as an investment through an IPO, but rather tapped the venture capital and private equity markets, which are extremely tough for people without seven plus figure net worths to invest in.
There are a few reasons why these technology companies have not IPO’d like similar companies have in the past, which I have outlined below:
- Today, companies are getting venture capital and private equity investments at some pretty high valuations, which back in the 90’s was much more possible through an IPO. These venture capital and private equity markets weren’t as lush as they are today.
- There is less regulation for non-public companies. No quarterly reporting requirements, less compliance, no SEC or PCAOB regulation, and less investors and analysts to answer to.
- There is less public scrutiny over your business when you aren’t public. Public companies get beat up pretty hard in the public eye. Miss one quarter’s earnings target and the media acts like you’re going under. When the only people seeing your financial results are a few investment firms, it becomes easier to manage expectations.
Now you’re probably asking – so what FF? What does this actually mean? That’s a good question. Could it mean smaller returns for equity index fund returns? Maybe. Could venture capital and private equity money dry up and growing companies start tapping the public equity markets again and find their way into our index funds? Maybe. Could it mean absolutely nothing? Maybe.
If Uber or Airbnb do IPO someday, they’ll be doing it with valuations over $25 billion and not $438 million like Amazon did in 1997. Therefore when our index funds buy these companies’ shares when they IPO, the potential ride higher has definitely been cut short due to how late in the game they are IPOing. I guess for the time being I’ll sulk a little knowing unicorns are hiding from my index funds, but at the same time I notice they may come back in the future.
Have you tried investing in venture capital or private equity? Does it even matter to an index fund investing strategy that companies like Uber or Airbnb are choosing to tap private equity / venture capital markets instead of IPOing?