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Late-Stage Investing: Outperforming Traditional Investing Without Massive Risk

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June 10th, 2020




Carmine Meoli

The historic bull market we experienced for the last 11-years has collapsed faster and more shockingly than ever before. It left behind people with the difficulty of finding suitable investments with attractive risk-adjusted returns in traditional markets, both fixed income and equity, seemingly overnight. So where are the profits to be found? Late-stage investing still provides one of the best risk-adjusted returns on the market, if you have the chance to get a foot in the door. Late-stage venture investing delivers increased predictability and visibility which often leads to a future IPO. It seems that whenever a promising IPO launches, everyone goes crazy. They spend an incredible amount of money on a stock, just to wondering and often regretting why they paid that much for a stock. Although IPOs can rise well beyond their future stable price, some buyers pick up stocks that they will need years to get the money back from. All of this assumes that one can get shares from often over-subscribed IPOs.

The Rate of Return on Venture Capital

“…the mean return on VC investments is 57 percent per year, still very large but less dramatic than the 700 percent mean before correcting for selection bias*. VC investments are still extremely volatile, with an annual standard deviation of about 100 percent. This is much greater than the roughly 10 percent standard deviation for the S&P-500 in the same period, but similar to the volatility of small publicly traded NASDAQ stocks.”

– National Bureau of Economic Research (NBER)

To summarize this study by John Cochrane, an NBER Research Associate, the returns on pre-IPO & late-stage venture investments are nearly six times higher than returns on the S&P 500 with about the same volatility as small NASDAQ stocks. His report states that the return can be as high as 700 percent, but there is an adjustment needed for start-ups that never take off. At Stableton, we work to mitigate that portion of the risk by doing late-stage venture investing, which implies the venture concept is proven and there is a great management team in place. Carmine Meoli’s blog, Late Stage Venture Investing: A Short Introduction to the Opportunity, gives you a further introduction to the concept.

High Return with Moderate Risk

The key to return in late-stage venture investing is that the investment comes in a very late-stage of value creation, often a bit before the stock finally goes public. An investor at this life-cycle stage can still capture some of the risk premiums that a private company investment brings along and is still enjoying a high upside potential in the form of a potential IPO but without the level of risk that early investors incur when these projects are in their infancy and subject to rapid collapse. These late-stage venture investments are done when the product-market fit has been confirmed and often there is already moderate sales activity. While there might not be a positive cash flow yet, the path to profitability is clear from present activity levels. Furthermore, the early management team has been tested and will have proven their ability to drive the project to fruition or, at least, to the edge of the market. While more experienced hands might be called upon later, the early team will have shown that they can successfully build a company. All of this makes valuations of late-stage ventures more predictable and based on where the firm will ultimately end up versus the significant levels of conjecture that make up most of the early stage reporting and funding appeals.

IPO Valuation

According to The Motley Fool, over 60% of 2019 IPOs were trading (in January 2020) above their issue prices. While that sounds great, it also means that 40% of all IPOs in 2019 lost money, some of them epically. Super League Gaming is one of those examples. Released at $11 in February of 2019, it was trading at $2.90 on April 20, 2020. Sonim, a company that manufactures rugged phones, has seen even more breathtaking falls. Also released at $11 on May 10, 2019, this stock is now trading at $0.84 (4/20/20). The problem that IPO valuation has is that it often cannot account for the very fickle stock market. Some IPOs offer products that are popular and successful, but the stock market doesn’t know how to handle them. They end up being very low priced simply because investors aren’t sure. One of the greatest assets of late-stage investing is that it’s a lot less about hype and “the talk on the street” and more about proven successes and data. Investors look at the offerings with clear eyes and decide if the investment has value as a business, not as a stock investment. Successful late-stage investments often reach the pre-IPO stage after 1-2 years and then finally go public after its final private financing round.

Too Late to the Game

For many truly massive IPOs, such as the Alibaba Group Holding Limited IPO on September 18, 2014, there is very little chance that an individual investor or even a small group of investors can get the stock. Institutional investors are able to enter the market and purchase massive lots of shares. That drives the price up rapidly. Alibaba’s IPO price was set at $68 on September 18, 2014. By the time the stock hit the trading floor around noon on September 19, the price had jumped to $92.70. That’s a 36% increase before a single share is traded on the open market. Contact Stableton or sign up to explore our investment opportunities The Alibaba example demonstrates how late-stage venture investing through Stableton has the power to deliver similar profits with less competition. To hop on an investment, even before it has reached the pre-IPO stage, means a lot of upside potential and source of alpha, while the risk level stays relatively moderate. At Stableton, our mission is to help investors getting access to the otherwise secluded private investment market. With a minimum of CHF 10’000, late-stage venture investing should be considered as part of a portfolio. We work together with individual investors, institutions, and investment professionals to deliver these outstanding opportunities. This article only scratches the surface of the investment potential of late-stage VC investing. Contact your Stableton representative to learn more and find out about opportunities that exist right now. *The mentioned selection bias is an upward bias, which only includes acquired companies or firms that had an IPO. Private companies are more likely to go public when they have achieved a good return. Those that do not achieve a good return are more likely to stay private or go bankrupt. Therefore, ignoring those companies that stay private only counts the winners.

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