Ever since former U.S. Treasury Secretary William Simon turned a $330,000 investment in then little-known Gibson Greetings into $66 million in just 18 months in 1984, ultra-high-net-worth investors have been trying and dying to get into the private equity game.
However, the apparent ease with which Simon made this fortune belies the extraordinary challenges of private equity investing for ultra-high-net-worth investors and the investment managers who advise them.
Paramount among the challenges are a daunting set of numbers and the need to create the right dealflow. If you ask most private investors, whether they invest as an individual angel or as part of a large private equity firm, they would tell you dealflow is their top concern in generating strong returns. Strong dealflow is critical because it provides better investment opportunities and the diversification needed to hit strong returns.
Enter crowd funding, which democratizes access to private equity deals over the Internet. The benefit of crowd funding sites is that they curate deals systematically. However, as with all new industries, there is not yet agreed upon conventions, and the quality of deals and the crowd funding site may vary. Financial advisors are cautioned to conduct due diligence on the site itself as well as the investment opportunities. These risks aside, the upside to crowd funding is compelling. For instance, according to Ewing Marion Kauffman Foundation research, the typical angel in, say, consumer products makes about 3.6 times their money in 4.4 years. Of course, not all transactions are successful.
We’ve seen encouraging participation from wealth advisors, but as a whole, the process remains in its infancy. What’s needed, in my view, is leadership from advisors in a few critical areas:
Due diligence and investment selection. Advisors can help educate their clients on the best practices with respect to understanding the merits and risks of new private equity opportunities. Identifying appropriate private company investments involves additional considerations than selecting public stock investments. Advisors can help educate their clients on considerations such as liquidity, holding time and valuation metrics. Investors should understand that investing in early-stage companies can be extremely risky and therefore need to know how to best incorporate that risk into their investment portfolios. By educating their clients on new resources for private equity investments and providing guidance throughout the process, advisors can position themselves as leaders in this new and emerging industry.
Fees. Some crowd funding sites charge no fees to investors. However, with respect to leadership, advisors now have the opportunity to enhance or increase the fees they charge by providing access to private equity investments, overseeing the investment process and monitoring investments. Essentially, advisors can help their clients access quality private dealflow without paying the double-fee structure of a typical private equity fund of funds.
Syndication. Advisors and family offices that handle multiple clients can amortize their hard and soft costs with respect to crowd funding-sourced private equity investment selection and due diligence. That is, once they have done the work for one client, it’s fair and prudent to offer it to other clients. Moreover, by aggregating investment dollars, advisors could, in certain situations, influence deal terms. Under the right circumstances, advisors could also gain board membership, which is perhaps as good as it gets with respect to oversight.
These are just a few areas where family offices and advisors can assert leadership in the rapidly changing area of private equity, and by doing so, differentiate their practices to gain a sustainable edge.
Ryan Caldbeck is the founder and chief executive officer of CircleUp, a crowd funding company that offers individual investors access to private equity transactions.
