Alternative Investors Eye Private Companies

Private companies are highly desirable investments. They usually have low liquidity, which means they're less vulnerable to downturns in the financial markets, and they can choose their own growth strategies. Because of these unique features, investors are now looking for ways to buy private companies outside of major markets like New York City and Silicon Valley.

The tech industry is one of the most popular industries for high-valued startups. In recent years, startups that are valued over $1 billion have been snapped up by huge tech companies like Apple and Google for large amounts of cash and stock. But with the increasing concentration of valuations in the tech industry, it's getting harder for startups to find investors outside of big cities.

That's why a growing number of alternative investors are looking to buy small, private companies instead. These companies are not large enough to be listed on a major stock exchange, like the Nasdaq or New York Stock Exchange (NYSE), but they still have significant value that can be extracted through an IPO or secondary purchase.

"We'd rather not be in the public eye," said Olen Kaehler, co-founder of First Round Capital, a firm that invests in private companies. "That's one of the reasons why we invest in these types of companies-we want to invest in businesses with good founders, but we don't want to have their business become public."

Kaehler said his firm has invested in over 100 private companies that have gone on to raise at least $1 million in funding. Some startups have raised as much as $40 million through IPOs or secondary sales. The firm doesn't list its investments on a public website, so it doesn't disclose its investment size.

Others are making their investments more public. Peter Thiel, a co-founder of PayPal and early investor in Facebook, recently announced he was starting a venture capital firm to invest in startups like Tesla Motors and SpaceX. He's already invested in Airbnb, Zenefits and other companies that have yet to go public. Thiel said he's looking for companies that can reach $1 billion valuations or higher with an IPO in the future.

While private investing does have some advantages over public investing like liquidity, one of the biggest challenges is finding companies that are undervalued by their market valuation but still have potential for growth. For instance, Facebook was passed over by investors in its infancy because it didn't have enough revenue or profit. But the potential for growth was significant, and eventually the social networking giant exceeded $25 billion in value.

Finding these hidden gems outside of big tech markets requires a lot of research. Investors need to find companies that have high margins and keep a large percentage of their revenues as cash on hand instead of reinvesting profits. They also need to find young firms with charismatic founders who can attract investors based on their long-term vision for the firm.

"In the Valley you have a lot of investors who really want to be entrepreneurs," said Brian Wong, founder of Valence Capital. "[That] naturally means they will want to take a large equity share in an early startup. My approach is much more focused on value."

Wong said his firm has invested in over 100 private companies that have gone on to raise at least $1 million in funding. Some startups have raised as much as $40 million through IPOs or secondary sales. The firm doesn't list its investments on a public website, so it doesn't disclose its investment size.

Some alternative investors are also looking for early stage opportunities that are still undervalued by their market valuation but still have business potential. There's a significant difference between valuing an early stage company and valuing a mature firm.

"In the Valley, there's a willingness to overpay," said James Beshara, co-founder of North Gate Capital Partners, which invests in startups centered around media and entertainment. "People want to pay $100 million for a company valued at $20 million because they feel that the startup is worth it."

Beshara said he prefers to invest in smaller companies with lower valuations because he believes it's less likely for them to become major companies that can attract big investments from venture capitalists. In some cases, however, Beshara does think larger firms can become great investments.

His firm recently invested in Pebble, a smartwatch maker that went on to raise $700 million in funding. Early investors were willing to pay high valuations to the company because they saw significant potential for growth. Beshara said he believes Pebble could one day reach a valuation of $10 billion or more.

"For investors, it's an opportunity to buy great businesses at significant discounts," Beshara said. "Because of the strong resistance from early-stage investors, we can buy these companies at prices that are significantly below what they're worth."

However, some alternative investors think it's too risky for entrepreneurs to rely on private investments as their only financing option.

"A lot of entrepreneurs think that private deals represent the only way to raise money so they can focus on growing their company," said Tom Alberg, an ex-investment banker who started eLance in 2005. "But that's not necessarily true."

Alberg said there are different ways to raise funding without going through the traditional VC industry. Some companies take out loans from banks, while others grow through sales of equity or debt financing.

"We don't write loan agreements for small businesses and it doesn't work well when you have a company that is structurally weak," said Alberg. "It can be a hard sell for a bank to agree to write a loan if the business is already deeply in debt."

Alberg said he won't invest in startups that haven't been able to raise money elsewhere. He also added that his firm will only consider startups with $100,000 to $500,000 in revenue, depending on the type of company it is.

"We're one of the very few investors who don't even have a problem raising money from angels," Alberg said. "We think that our model is better than what most VC firms are doing these days."

Not all alternative investors are so focused on lower valuations and revenue targets.

Conclusion

For now, the future of alternative investing looks bright. The rise in angel investing has attracted new entrepreneurs and some big jobs, like the President of the United States. It's not hard to imagine a future where startups are funded by multiple private investors, so firms like Uber or Airbnb don't rely on just one or two large investment deals.

Source: New feed3.info/vitalsigns/venture/private/angel_investing_is_gaining_ground-211426.