Some Americans are getting seasick from Wall Street volatility and are looking for alternative investment options. You may be considering alternative investments as well for placing and growing your money.
But, where to start?
Start where the wealthy put their money. Institutions, such as hedge funds and university endowments, as well as ultra-wealthy investors have long invested in private markets as an alternative to the stock market since growth and returns in the private markets have outpaced those in the public market.
Where should one start with so many investment options out there?
How does an investor wade through all the noise, especially with the proliferation of crowdfunding, private placements and other non-public offerings readily available to the investing public due to recent changes in securities regulations?
Private investing can take on many forms, direct and indirect, including angel investing; venture capital; private equity; hedge funds; and direct real estate and business investments. Let’s put ourselves in the shoes of many ultra-wealthy investors and experience their elimination process for arriving at their preferred avenues for placing their money.
First, let’s assume for purposes of this discussion, like most ultra-wealthy investors, you prefer not to start your own business or manage your own real estate investments, so we will eliminate direct investments from the private investing discussion. You’re more interested in passive investing. In other words, you’re willing to defer to the expertise of others for running the show.
Next, we’ll eliminate hedge funds because even though they fit the definition of private investments, they invest in public equities, exposing your investment capital to the Wall Street volatility you’re trying to avoid.
That leaves us with angel investing, venture capital and private equity.
Between the three alternatives, angel investing and private equity are the most similar in that they are passive investments in one company involved in typically one line of business or market.
A venture capital firm is a financial cousin of a hedge fund in that it is essentially a fund of funds. The difference is venture capital firms make private investments in pre-IPO companies with more direct involvement in the management and direction of these companies; whereas hedge funds take a hands-off approach by investing in publicly traded equities. For the ultra-wealthy investors who like to have direct access to the managers of the businesses in which they invest, venture capital investments don’t provide this access.
This leaves angel investing and private equity.
Angel investing involves the investment of cash into typically the very early stages of a startup company. Angel investing generally is less formal than a private equity investment. Because these deals are often done with a handshake, angel investors are required to be accredited investors where the information required to be provided by a start-up are less onerous than those required to be provided to non-accredited investors when raising capital.
For that reason, angel investing can often be a crap shoot. With angel investing, over 90% of startups fail, and of the ones that don’t fail, very few reach the IPO stage. Angel investors are often ultra-wealthy, have a high tolerance for risk and can afford to lose their entire investment. Angel investors are often friends and family since that is where entrepreneurs turn to first for seed capital.
In 1995, Jeff Bezos’ parents invested $245,573 in his fledgling e-commerce site. Their investment in Amazon is estimated to be worth $30 billion today. However, for every Amazon, there are a thousand pets.com’s and drkoop.com’s.
Private equity investing, which also encompasses debt investments, involves direct private investment in startups in exchange for equity or debt securities. These securities are often offered through formal private security offering exempt from registration under SEC regulations.
With the recent rule changes by the SEC allowing for the advertisement of private offerings (formalized by the JOBS Act), the investing public’s level of access to private equity investments is unprecedented.
Never before have investors been able to find private investments that not only align with their economic objectives but also with their social philosophies as well. Witness the proliferation of investment opportunities now focused on the environment and green technologies.
Because private equity investment offerings are typically past the seed stage and are more formal than angel investing, they are typically conducted through a private offering exemption accompanied by a private placement memorandum along with mandatory and comprehensive disclosures about the company’s principals, business, financial data, risks, etc. The information disclosures associated with private placements far outweigh those provided in connection with angel investing, allowing for more informed decisions.
In many cases, private equity investors are interested in an exit strategy such as an IPO or an acquisition to cash out their investments. Facebook, Snapchat and the impending Uber IPO all got their starts from several rounds of private placements.
Many ultra-wealthy investors who favor cash flow, as well as appreciation, turn to private real estate funds.
A majority of ultra-wealthy investors invest in private real estate because of the above-average returns, tax benefits and as a hedge against inflation. Brunswick, Robert, “Why High-Net-Worth Investors Seek Increased Real Estate Allocations,” Aug 03, 2017.
Private real estate funds present the best of both worlds to ultra-wealthy investors seeking the income and asset-backed advantages of real estate investing along with the ability to enjoy hands-free ownership through a passive investment.
So if you’re tired of Wall Street’s volatility and you’re seeking passive income investment opportunities with above-market returns like many ultra-wealthy investors, you may want to consider private real estate investing.