Beware of Bankers Bearing Pre-IPO Gifts
(Bloomberg Opinion) -- Bulletin for investors intrigued by reports that Morgan Stanley is planning to give its very wealthy clients exclusive access to shares of buzzy startups before they go public: Be very afraid.
It's natural to be seduced by the thought of scooping up shares of the next Airbnb Inc. at a discounted price, but this is no time to abandon caution — even for those with at least $20 million in assets, the reported threshold to participate.
The venture isn't supposed to launch until next year and details are fuzzy, but it's likely that companies featured on the platform will be those that get money from venture capitalists.
Returns for venture capital investments tend to be volatile, to put it mildly. As of late, performance has been breathtakingly good — from 2009 to 2019, the average venture-capital fund outperformed the Standard & Poor's 500 Index by more than 10% a year, according to research from Steve Kaplan, an economist at the University of Chicago Booth School of Business.
But that's no sign that investors who start tapping Morgan Stanley's offerings will enjoy those same returns. From 2000 to 2008, the average venture capital fund had pretty measly returns, underperforming the S&P 500 by 1%. Considering the fees and illiquidity that often accompany these kinds of investments, such subpar performance is especially painful.
Investors should also be wary of all of the money that's been flooding the venture capital market — almost $100 billion so far this year, a record. According to Kaplan, there's a negative correlation between money flowing in and subsequent returns in venture capital and private equity. Venture capital funds performed poorly after big money poured in during 1999 and 2000; the same thing happened with private equity funds after money flocked to the space from 2006 to 2008.
Valuations, especially for tech stocks (which Morgan Stanley is likely to focus on if its previous pre-IPO deals are any guide) are also soaring these days, making disappointment more likely. Take this important metric, compiled by Jay Ritter, a finance professor at the University of Florida, which compares the price of a stock to its revenue: From 1980 to 2020, a company's offer price (or the price set by an investment bank for its shares during an IPO) was about six times its 12-month revenue for the median tech stock IPO. Now it's more than 13 times revenue, according to Ritter.
There's also something potentially worrisome about Morgan Stanley's private shares platform. According to the Wall Street Journal, which first reported on the bank's plan on Tuesday, Morgan Stanley will work with companies to set their own share prices. While that’s likely to make the founders of startups happy, it may not be in the best interest of investors. Company executives may have inside information to more accurately price shares, but they also are typically loath to help cut prices of shares in subsequent funding rounds.
Remember, Morgan Stanley's attempt to offer shares of Uber Technologies Inc. to its wealthy clients before the ride-sharing service went public in 2019 has yielded disappointing results. The firm's latest venture doesn't seem promising, either.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, she oversaw tax coverage for Bloomberg News.
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