Accessing the Private Markets | AWM Insights #154
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Episode Summary
Private Markets are not open to all investors. There are minimum thresholds that need to be met to qualify individuals to invest in this space. These rules are set to protect smaller, less sophisticated investors from the challenges and complexity of the Private Markets.
On top of the regulatory requirements are implicit hurdles. In Venture specifically, having the funds to invest is not enough to access the best managers and get a seat at the table.
Our Multi-Family Office structure and commitment to networking give our investors strength in numbers and enable us to access the highest quality private offerings.
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Episode Highlights:
0:00 Intro
1:28 What is Liquidity and how does it impact Private Investments?
4:45 Why your financial structure needs to be dialed in to invest in Private Investments
6:35 What requirements are needed to invest in Private Markets?
10:13 Why Access matters so much?
14:01 Text us!
+ Read the Transcript
Brandon Averill (00:02): All right, we're back for session two of this series, Justin. We hit on last time around what is the benefit of venture capital, why do we spend so much time in that market and really what's the opportunity? I think hopefully everybody left there pretty excited about the opportunity and venture. The fact that it does give you the highest expected returns. There's a lot of innovation that you get to be a part of. The networking effects. So tons and tons of positives, and what we probably assume is that if you listen to that episode, you're walking away going, "Shoot, sign me up, I'm ready to go," and kind of one of those things where if this is the story, if it is all that good, why doesn't everybody do it?
(00:50): So that's what we're going to spend a little bit of time on today, and those three big reasons that we feel like keep everybody from participating in this, at least this asset class, at least responsibly, and so we're going to dive into some of those things today, but to cut to the punchline, it's something we call liquidity, which you probably have no idea what that actually means. So we're going to explain it today. We're going to talk a little bit about your resources. Do you actually have the resources to participate? Then lastly is something that does get talked about quite a bit, and that's access. So let's jump in at the very top here, Justin. Liquidity, what the heck does that word mean and why is it important, and maybe why does this prevent or why should this prevent a lot of people from participating here?
Justin Dyer (01:39): So we'll try not to throw cold water on episode number one throughout this one. So liquidity, let's give a real basic definition of what that is, and I would say simply it is the ease and amount of time that's required to turn an asset, whatever it may be, into cash. That could be your house, that could be a collection of baseball cards, wine, you name it. Your "investment portfolio" has liquidity characteristics. So does the private markets. So does venture capital.
(02:19): Private markets, just kind of by the nature, if you haven't picked up on this yet, are more what we call illiquid than the public markets. Public markets, you can either have your own personal brokerage account, or we have brokerage accounts for all of you, our clients listening, and we can go and trade right now. It's market hours as we're recording this, and we can go hit some buttons and turn a stock or an ETF or a mutual fund, something that is held within the public markets, into cash relatively easy, relatively quickly, versus the private markets... You basically can't do that.
(03:01): With ventures specifically, the way these funds, these vehicles are designed, are to have a lifespan. Typically that's a 10 year fund, with some extensions and things like that, which we're not going to address. We'll set that piece of it aside, but you are investing with the expectation that you're never going to see this money or you're not going to see this money for probably a six to 10 year timeframe. You might start to see some of it come back within six years or so, and then the full life cycle of the fund will be somewhere around that 10 year timeframe. So it is very illiquid.
(03:37): There are ways in which you can go sell outside of that timeframe, but there's some costs that are involved with that. So liquidity, and that's just something that takes some comfort to get around. This is not just unique to venture. This is really unique, I think I hit on this, to the private markets overall. Venture specifically is a long duration or longer time to liquidity than most private investments, because if you think about just the nature venture, you're starting a company from a very, very early stage, or you're investing in a company from a very early stage, in some cases from day one, and this company has to season, has to prove itself, and that takes a lot more time than an already established private equity type investment or a real estate investment, for that matter, where the life cycle could just be a little bit shorter.
Brandon Averill (04:30): So I think that's a great summary, and so simply, it's just the ability to take whatever you own and turn it into cash as quickly as possible, at the lowest cost possible, and I think what we often see is when we have new clients come aboard, is if they have a couple of these investments out there, they didn't quite grasp the full concept of, especially on the venture side, the stats are kind of staggering, companies are staying public longer, and a good reminder is how you actually make... A couple ways to make money is you need... This company that you're investing in or this fund has to sell at some point, and that means it's either going public or it has some other company that acquires it. Those are the two main ways that you're going to get that return on the capital you're investing, and it's taking companies 11 years to go public. It was the last kind of median measurement that was produced out there.
(05:29): So when you think about that, you've just got to be ready. It's also why turning back to financial structure and how we think about all your guys' portfolios is, this is why we harp on the priorities. We really try to understand what access to money are we going to need to achieve your essential for sure, but also most of your important priorities, and we often make this comment to you guys, the reason... Or when you go to invest in venture capital, you almost mentally need to think about it. You're not really investing for your lifetime. You're investing for the next generation, and so you're using assets and resources that you have that you never really plan on using in the future, and so that's what allows you to participate in this category, allows you to have the opportunity to grow your money. So it really does come back to a financial structure kind of problem or issue.
Justin Dyer (06:25): That lines up or dovetails, sets up whatever you want to say for reason number two, which is resources. That whole exercise is trying to figure out what resources are available from your unique portfolio, going back to podcasts we've recorded in the past around how we structure custom portfolios. It's really important to go back to that, which is what exactly you did, and it points to what resources are available to you, but also, you hit on number two here, resources, where the regulatory world in which we live in, for better or worse, also restricts access to it based on resources. So you do need a certain level of either outright investment resources or earnings to participate typically in the private markets.
(07:17): There's two terms... We won't go too much into the weeds. Two terms will definitely hit on. Accredited investor and qualified purchaser. Qualified purchaser is a more stringent criteria that the SEC has come out, basically saying, "Hey, you need five million dollars or more in investible assets that's outside of your primary residence," in the very basic definition, and guess what? A lot of venture funds require you to be a qualified purchaser to participate. So the barrier there, the resource level, is quite substantial.
(07:50): Accredited investor is a little bit weaker, and some people subscribe to that, but typically the best of the best, and we're going to get into access next, the best of the best require you to be a qualified purchaser. It gives them a little bit more flexibility from a regulatory standpoint, and puts them less under the microscope with the SEC specifically. So there's both resources specific to you and your portfolio and your priorities and the custom nature in which we view all that stuff, but then there's also this regulatory resource definition or requirements as well.
Brandon Averill (08:26): I think a good analogy for this that we often go back to, and I'm going to bring it up again, because I think it's helpful, is it's a lot like golf. When you think about these different segments, you've got your public course. We can all run down to Brookside, which is right outside the Rose Bowl here in Pasadena, and we can play around to golf, no problem. We flop our 50 bucks on and we go play, and then for clients listening, especially the ones in Arizona, you can go join Silverleaf. It ain't cheap. You better have some cash. You better have some cash to be able to join it. It's probably a hundred thousand dollars buy-in, your monthly dues are a couple grand. So it really shrinks the pool of people that can go participate in that. That's a lot like what's called the accredited investor, that kind of middle tier.
(09:14): Then there's this place that, every March, everybody gathers out in Georgia, in Augusta, and that's Augusta, Nashville, and they don't care how much money you have.
Justin Dyer (09:25): Know the right people.
Brandon Averill (09:27): You have to know the right people, maybe you've got to... You'd certainly have to have the money. They're not letting any Joe Schmoe in there, but that's really the qualified purchaser, right? That's the bar, that's the elite of the elite that's going to get you on the best course. It's probably likely to get you the best access in the private markets, and so the government at least does that kind of general thresholds, and that ultimately leads to probably the last leg of this that we've talked about, is access. So just because you get to go play Augusta doesn't mean that... Maybe you're not a member, et cetera. I don't know where the analogy kind of stops here, but it becomes an access type game. So yes, on paper, you have the ability to go participate, but I guess where it does continue, the analogy is you may have the money, but if you're not part of the club, they're not going to let you out there to play. So I think that's the last part of this, is how do you actually get access to the right opportunities? Does everybody get access once you have $5 million? Maybe extrapolate that and talk about how we get access for our clients.
Justin Dyer (10:37): So I think this topic, broadly speaking also touches on the risk profile, and even our first podcast in this series, where because of the sexiness of venture, because of the outright absolute returns, people are like, "Okay, well yeah, I want to do this," and throw money at the category without any level of sophistication or analysis or whatnot, and they're the access piece of this. If you look at the playing field, the difference between top tier and bottom tier is staggering. It's the widest of any asset class. A lot of asset classes is you're like, everyone's kind of close. You do have some outliers here and there, but everyone's kind of close in the middle. Venture is not like that, and part of that is because people do chase the asset class from a pure return standpoint and don't do it the right way. So that's kind of a broad comment.
(11:32): The other thing I would say is because it's a relatively small asset class and you just think about the nature of it, it's kind of more of a craft than just this typical financial... Let's call it financial practice, where you're spending days in spreadsheets. Certainly there are elements of that. You need to understand the investment you're making, the business you're making, but it is this one-on-one relationship between venture capitalists and founders and trying to get these companies started. So it's a slow, relationship driven business at its most finest point, if you will, and that also extends into the network of investors. It's a relationship driven business.
(12:23): Yes, you need capital to your point, but it's a great analogy that you highlighted with Augusta, that they want venture capitalists and investors and even founders, for that matter, want engaged partners. They want people that understand what they're doing, that are going to be there long term, that can withstand the 10, 11 year cycle to going public if everything goes well, and then even for our clients as well, the ability to have some sort of value add doesn't matter. The celebrity aspect of athletes potentially, or even the value add nature of past founders or existing founders, there is this symbiotic network. It's not just like, "Hey, give me a big check, and then I'll see you in five, six, seven years." Venture capital is not like that in any way, shape or form.
(13:14): So the best of the best coalesce around this network in this community, and it is really, if you're in, you're kind of in. If you're out, if you're just chasing venture capital to chase venture capital, you're probably, just through adverse selection, getting the lower tier, lower 50% of the opportunities, and you might as well just invest in the public markets at that point.
Brandon Averill (13:36): I think the last thing I'd just like to hit on is access is also a business model type thing, and how you can actually get access. So for clients listening, this is one of the big benefits of you being a part of a multi-family office and us having an independent structure. So we have the ability to go out and access these markets, spend a lot of time there. Unfortunately, by comparison, I was on the phone yesterday with a broker at one of the big wirehouses... I guess I'll throw out a few. Wells Fargo, Goldman, and Merrill. It was one of those three, and we'll throw Morgan Stanley in there. It was one of those four, and he actually made an interesting comment.
(14:14): He's like, "Hey, yeah, actually, personally I'm invested in this fund," and I was like, "Oh, personally? Oh, do you put your clients..." "Oh no, I can't do that. It's not approved on the platform."
Justin Dyer (14:24): Oh yeah.
Brandon Averill (14:25): So it was kind of funny just to hear, and a good reminder that... I love what you said about relationships, because that is how you get access to that, and so often, what this turns into is a very product driven asset class. So somebody will be pitching a deal or something that doesn't have a lot of systematic sustainability to it, and it's more about, "Hey, let me get you really excited about this one story or one idea, and let's put money in," and then kind of leaves from there. So it's very product driven, and so just really, I think everybody should know that it is that kind of nature of the independence, the robustness of having an open architecture to go build a customized portfolio, is what ultimately gets you the access to these types of opportunities.
(15:18): So we'll wrap up for today, but I think what we should dive into next episode, Justin, is likely, okay, great, why venture? I'm excited about that. We can go get the returns, et cetera. Okay, why? Maybe I'm a client and I'm listening to this, and I don't have that venture allocation. Hopefully we answered some of those reasons why you don't have it yet, because if you're a client, we certainly have the expectations you're going to get to the point of being able to participate in this sector, but then let's move on maybe next episode and talk a little bit about, okay, we've wrestled with the opportunity. Now we've satisfied all these reasons why we maybe won't invest in it, so how do we actually go and invest in it? So we'll hit on that next time, but we'll wrap up for today, and we appreciate your attention, and as always, own your wealth, make an impact, and always be a pro.