Placing the opportunity for ordinary investors to invest in hot pre-IPO companies in a fund required SharesPost to first answer a question: how exactly would the fund be structured?
Finding a solution, explains Sven Weber, president of SharesPost Investment Management, meant taking on the biggest investor concern - the fund's underlying assets would be private, illiquid stock. How could an investor have any confidence that they could get their money out, if at all? Weber says research and feedback brought them a well-fitted solution.
"Our fund is structured like an internal fund with a quarterly redemption process, so that addresses some of the illiquidity concerns for investors," Weber tells Money Management Executive. "There's at least a path out. Yes, it's not like an open-end fund where you can get out every day 100%, that's not possible. But we try to address some of the illiquid nature here."
In addition to finding an innovative way to use an existing closed-end fund structure for underlying illiquid assets, Weber's SharesPost 100 Fund has quickly made a name for itself with its SharesPost 100 List, which highlights pre-IPO companies deemed worthy investments.
Weber discusses the heated investment in the pre-IPO tech market, how the fund manages risk, and selling prospects on a fund with higher fees than most popular ETFs in the market.
You've discussed the recent froth created by hedge funds for pre-IPO tech companies. How does such activity affect your fund's business model?
In my business model, if people are willing to pay a lot of money for companies, that's fine. At that point, I make money. The concern I have comes back to what happens when certain enterprise expectations don't play out, and how do I do it then? In my model, given that I'm not investing shortly before an exit window but rather two or three years before that, theoretically my cost base is lower so I should be able to digest valuation pressure before they become $10 or $11 billion enterprises. If I bought at a lower cost base, I'm still doing fine. That's basic logic. The outstanding concern is, can a correction play out in one of these companies and suddenly take out other companies, creating a ripple effect either in the sector or across sectors? So I'm watching it very carefully.
I've told others that many of these valuations are more marketing numbers than real enterprise values, as these financing rounds are structured as preferred rounds with guaranteed returns for these investors. So you have to know these kinds of things, such as what kind of stock class you're buying if you're going in. Definitely common stock is more challenged than preferred stock. There's a lot of internal safeguarding for these investors who come in at a $10 or $30 billion enterprise value. If you know what you're doing and you understand the structure of these private companies, and you understand the logic of private deals - what happens at Payday, for instance - then you have the tools and you have to make the right investment decision. Reading about a company in the newspaper, and saying to yourself, ''Great, it's got a $10 billion valuation,' and then begin buying without understanding the internal structure, then you will have a problem.
Our approach is to dive deep into these internal structures and understand the enterprise value for each class of stock, and provide insight into which company you can buy, which class of stock and which price. That is very important to us to secure our downside here. So I'm cautiously concerned in some of the companies, and I will do whatever I can do with my current investment strategy to take care of housekeeping within those internal structures.
Given the caution you bring to the fund's operations and investments, do you get frustrated when SharesPost is described as 'risky' because you are investing in pre-IPO companies?
I gave up getting frustrated years ago, because I realized then that the public market might be more risky than the private market. In the public market you have a 50/50 chance if it works or not. Good public investors are right 51% of the time and wrong 49% of the time.
Here, people mix venture capital, where if you have an early stage profile with a security risk of 30 to 50% in the companies, with the late stage profile, where I am.
Late-stage ventures are less risky, and again, knowing the internal structures of the stock, you have things like liquidation preferences, among other things that secure your downside. Sometimes you might have that. But I understand this is the perception, that this asset class is seen to be risky. Another thing said is that this asset class is typically highly illiquid, and I think this is the real problem. People have invested in illiquid private stock, so that is the main cause of unease, that you can't go out quickly, and what happens if it goes down and you can't get out in time. So they mix risk and illiquidity, and put it into one basket.
Our fund is structured like an internal fund with a quarterly redemption process, so that addresses some of the illiquidity concerns for investors. There's at least a path out. Yes, it's not like an open-end fund where you can get out every day 100%, that's not possible. But we try to address some of the illiquid nature here.
How have prospects taken to the idea of investing in a pre-IPO through your fund offerings?
It's been very positive. I think it's important for people to understand that I'm not going in six months or 12 months before an IPO. Typically what we say is that if you read in the newspaper about how successful the company is and what kind of large valuations they are getting, then that's too late and you should not expect me to invest in that company, unless I find the right stock within that company.
When I add companies, they expect that you probably haven't heard a lot about them, but with a little digging you can find a significant amount about that company. So these are firms on the verge of getting significant press.
That's the important thing. Often I hear, 'Oh you're messing with pre-IPO companies, like Lyft and Uber.' And I tell them, 'No, that's too late for me.' The current Uber is too late, but I am looking for the future ones that are sitting out there at a half-billion dollar enterprise value.
How does your firm broach the subject of fees with prospects who may have gotten accustomed to the low costs of passive ETFs? How is the fund's value proposition explained?
People are just getting hammered by 2 and 20. So we are definitely positioning ourselves as a fund that is not following the 2 and 20 model for this kind of investment. Yes, if you compare it to the low-fee models, we are higher in cost than them, but so far our performance shows that we are getting alpha. So there are higher fees than ETFs, but there is quality. There's a lot of work involved, and someone has to do the work. It's not something that you can do for a few basis points. But we don't get any pushback on 190 basis points, especially from people who had been in the 2 and 20 model.
How did you garner support for the fund, and what were the regulatory issues that needed to be cleared?
We originally looked at different structures. When we had our initial filing we had a different structure, not as a closed and internal fund. But we got a lot of feedback from financial advisors and people on Wall Street, and we got to a point six months in the process into this interval structure that was designed decades ago specifically as a fund structure for illiquid underlying assets. When we looked at that, we said, 'Wow, that actually makes sense.' So absolutely, the SEC and the regulators did a good job in defining for a 1940 Act product illiquid underlying assets, so why not take it? This was for real estate and other illiquid assets, never for private equity, but given the feedback that we received - investors are protected, you're getting in net asset value, you're getting out net asset value, there's little trading risk, it's not a 2 and 20 model - there were just many positive things that just made sense, and that's when we chose to go with half of a closed end interval fund.
From there on it was just standard SEC work, because it wasn't an unusual structure for them. The SEC was more interested looking into how, since it was being used for something that hadn't been done before, was there anything that they had missed. They looked at our valuation procedures, they looked at how we allocated the money, conflicts of interest - all the usual things that they'd do with any fund. I think they maybe did a little more than usual because the structure was not used before for private illiquid stock. We got approved last March, and are going to be celebrating our one-year anniversary.
In total, from the time we restarted, it was about 11 months. And we had some things happen - one of the examiners retired, and then there were two months where the SEC was shut down because of the weather. But I have to give the SEC a lot credit. They very thoroughly looked through it.
SharesPost puts out a list of pre-IPO companies that it deems interesting. What sort of response from the firms does that elicit?
The list was designed specifically to be a list of companies to invest in with the fund. We launched a list just a couple of months before we launched the fund itself. So people thought that it was just a marketing effort. And when we launched the fund, it had an 85% concentration policy in these names. That's when people realized there was much more behind that list than putting names out there.
The perception of our company has changed dramatically over the last 12 months. We've been gaining a lot of interest - when we first put them out there, the response was, 'Okay, yet another list.' There are so many people that put out the 'Top 50,' of this or whatever.
When we updated the list in January, a few of them actually issued press releases that stated they were proud to be on the list. We even have companies that put it in their corporate description, that they are a SharesPost 100 company.
So it's getting a reputation of being a seal of approval or a quality stamp for being on the list, and companies approach us when they appear on the list, and ask how we can work together. It's been good. That has happened a lot faster than I expected.