Tech stocks have been on a tear. In the last ten years, the NASDAQ Composite -- an index that tracks the 3,000+ companies listed on the exchange, many of them in the technology, media, and telecommunications (TMT) sector -- returned 394%, compounding at 17.3% per year.
Suffice to say, tech companies are eating the world, and Silicon Valley is having a field day. Hundreds of the Valley's venture capitalist-backed start-ups made their public debut last year, including household names like Duolingo (DUOL +4.73%), Bumble (BMBL +0.31%), Robinhood (HOOD +6.31%), Udemy (UDMY +1.32%), NerdWallet (NRDS +2.67%), and Affirm (AFRM +6.48%).
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These initial public offerings (IPOs) are big milestones for private companies. Not only does a successful IPO signal that a start-up is large and mature enough for the public sphere -- it also represents a windfall for the company's insiders, many of whom may make millions or even billions the moment the opening bell tolls.
To become an insider, you'll either need to be an employee or an investor at the company -- the earlier, the better. Investors who purchase a stake at the very beginning of a start-up's life are known as angel investors or "angels", so called because they provide capital to a company well before banks or other lenders are willing to.
But not everyone who wants to can become an angel. Angels are required to be accredited investors -- wealthy individuals who have annual incomes above $200,000 or a net worth in excess of $1,000,000.
So, if you're among the vast majority of folks who aren't rich, are you missing out? After all, angels get to put their money into promising young companies at the very start, while the rest of us can't touch a company until it goes public. Does that mean we're condemned to lower returns?
Exclusive, but not necessarily better
While 10% of all investors are accredited, it's estimated that a mere 300,000 people have invested in a start-up within the last two years -- less than 0.1% of the U.S. population.
For this exclusive group of investors, however, returns are often unspectacular. Between 1990 and 2007, 39% of angel investors lost money investing in start-ups. Though the remaining 61% made something, few truly hit it out of the park -- only seven percent of all start-up exits returned more than tenfold the initial investment.
This isn't the only piece of disappointing news. Startup investments are also costly, with minimum check sizes frequently in the five to six figures. In addition, they're highly illiquid stakes, meaning that angels can't buy or sell their investments with ease. In fact, the average holding period is 3.5 years, and that's with no guarantee of profitability.
The reality is that for most angels, the chance that their start-up becomes the next Facebook or Google is slim to none. Only 0.00006% of all start-ups will ever achieve a $1 billion valuation. Known as "unicorns", these billion-dollar companies are so magical, rare, and unlikely -- they might as well not exist.
In short, you're really not missing out on much if you're not an angel investor.
Sometimes, it's best to keep things simple
So, what does this mean for the humble public market investor?
For one, it means that there's no reason to catch the FOMO bug -- angels aren't leaving you in the dust. Rather, tech stocks fare well even after they go public, and the largest technology firms today have created the vast majority of their value post-IPO. For example, when Amazon (AMZN +3.51%) IPO'd in 1997, it was worth just $438 million. Now, it's valued at $1.5 trillion.
Next, in terms of liquidity, you're even at an advantage. Trading companies listed on public exchanges means can you receive live price quotes or get in and out of a position on a whim -- which exposes you to less price opacity and risk.
Third, public equities are more affordable. You don't have to bet thousands on one start-up -- a single share in a NASDAQ index fund can get you broad exposure to hundreds of different companies.
Finally, you don't need to be an early investor to feel like an "insider". Public companies regularly disclose a treasure trove of information to the public in the form of earnings calls or annual and quarterly reports. Comb through enough of these filings, and you too can become an expert on the business.
In summary, simply buying and holding a well-diversified basket of tech names after they've gone public may lead to higher and more predictable returns than investing in what are essentially illiquid lottery tickets as a start-up angel. After all, you don't need exposure to private markets to do well. Oftentimes, the most straightforward strategy is also the best.
