The Private Innovation Economy

Given the shift of capital from public to private markets, and the trend of high-growth companies staying private longer, Liberty Street Advisors’ Christian Munafo explains how investors can tap into these dynamic, innovative and revenue-rich late-stage US businesses during their most exciting development phases.

25 June 2024

Over the last decade we have witnessed a dramatic shift in capital from public to private markets. Whereas most venture capital (VC)-backed companies have historically generated the majority of their capital appreciation in public listed markets with broad investor accessibility, today these disruptive high-growth companies continue staying private for longer while scaling under private ownership with far less investor accessibility. Furthermore, two-thirds of private innovation companies have historically been acquired rather than list publicly. Consequently, much of the growth opportunity set has moved out of reach for investors limited to publicly traded company shares.

While these dynamic companies are prospering and growing rapidly in the private market, the number of publicly traded companies on U.S. exchanges has contracted significantly over the past 25 years. This trend can be largely attributed to a combination of new regulations and the 2012 JOBS Act which expanded the ability of companies to raise capital privately. As the below chart demonstrates, nowadays companies are staying in private ownership for far longer while appreciating in value more than any of the emerging innovators from two or three decades ago.

Staying private for longer 

Companies are leaving the Private Markets as larger companies  

The result has been that many public equity investors now face missing out on the growth potential of disruptive, private innovation-driven companies – many with proven business models and already in profit – during the most exciting phases of their development.

Building upon a decade of broadening investor accessibility in the U.S. – and more recently Australia and Asia – to the private innovation economy through the GAM LSA Private Shares strategy, we look forward to the prospect of being able to offer the strategy to investors in Europe. In the meantime, we remain focused on leveraging our extensive proprietary origination network to identify and access leading, high-growth private companies at a later-stage which we believe can potentially generate attractive risk-adjusted returns.

Tap into an expanding, high-potential opportunity set

Today, more than 75% of US companies generating at least USD 100 million in revenue are private, representing a greater portion of the overall economy than ever before (source: Liberty Street Advisers). To be more specific, there are roughly 15,000 late-stage VC-backed companies in the US representing more than USD 1 trillion in fair market value. So, any investors unable to access these dynamic, revenue-rich, high-growth businesses while they are still in private hands could miss out completely on the opportunity to invest in them – at any point. Furthermore, we believe our focus on later-stage private innovation companies already generating significant operating metrics with proven business models, experienced investor syndicates, seasoned operators and strong governance helps pave the way for attractive risk-adjusted return potential.

Bridging the liquidity divide

The structural illiquidity and inefficiency of private markets often create attractive entry point opportunities to these companies during normal market conditions. During periods of increased market volatility and macro uncertainty, the ability to negotiate favourable terms increases due to the combination of sidelined capital and increased liquidity demand. As a result, there is currently a significant inventory of attractive opportunities due to supply-demand imbalances which will likely persist for the foreseeable future, thereby creating what we believe is an exceptional time for capital deployment. That said, we are also monitoring various market signals which we believe point to a positive shift in sentiment that should bode well for owners of these leading assets during the next cycle. Overall, while we continue to see opportunities to generate significant returns in this asset class, it is important to understand the liquidity terms and conditions before investing in late-stage VC. To help address this issue and aim to offer investors an improved liquidity profile, the GAM LSA Private Shares strategy that is available in the Australian market offers a daily application and quarterly redemption feature that enables up to 5% of the fund to be redeemed each quarter.

VC – a breeding ground for future champions and disruptors

Seven of today’s largest US market capitalisation companies started as ambitious ideas in search of early-stage VC funding. As those companies have now become the established incumbents - which often leads to less innovation - we see the next generation of disruptors surface, including some that may create entirely new markets. While we support the entire VC ecosystem, we believe late-stage VC companies offer investors the most attractive risk-adjusted opportunity to potentially capitalise on the next wave of innovation in areas such as Generative Artificial Intelligence (AI), cybersecurity and the space economy.

VC-backed companies drive global innovation …

Dedicated to the private markets space

Having developed trusted relationships with participants across the spectrum - from entrepreneurs, VC dealmakers and private equity companies to IT industry network professionals - we have demonstrated an extensive ability to invest directly in companies, rather than adopt what is, in our view, the much less efficient fund-of-fund approach employed elsewhere. By implementing a combination of investment tactics which includes secondary transactions and participation in new rounds of financing, we look to access high-quality securities in leading companies at attractive prices. Importantly, our long-standing relationships throughout the VC and growth ecosystem and extensive transaction experience enable us to optimise various private market dislocations and inefficiencies by negotiating favourable terms for our investors.

A valuable portfolio diversifier with low correlation

Over the past decade, we have developed a disciplined, institutional-grade process-orientated approach using a comprehensive due diligence framework to optimise our asset selection and how we structure transactions, with the aim of constructing diversified portfolios with attractive risk-adjusted return characteristics. And when we invest, we tend to think in terms of multiple years ahead, not multiple quarters, thereby focusing our investments on late-stage disruptors that we believe are positioned to exit over the next three-to-four years. Said differently, we are investors, not traders. While many of the companies we target exhibit similar, or in some cases far more attractive operating metrics than small-to-mid cap growth companies in the public markets, we believe the private market comes with less volatility and lower correlation to listed markets, which can be attractive diversifiers for investors’ portfolio construction. Although the risks of investing in the asset class include the cash flow inconsistency and changes to the competitive landscape as dynamic companies grow, we believe that a strategic approach to managing these risks, backed by the experience, expertise and insight to navigate the asset class effectively, represents a strong proposition to deliver attractive long-term returns from investment in high-growth, late-stage private innovation companies.