By Elliott Detjen
When John Bogle released the first index mutual fund to the general public in 1976, the world of investing crossed a Rubicon. This precursor to the Vanguard 500 Index Fund not only transformed the existing market but, more importantly, expanded it to include new horizons of ordinary people. With as little as $3,000, the everyday American could now peel back the iron curtain of finance and participate in what used to be accessible only to those who tread its marble halls. Since 1976, Wall Street has seen the emergence of other democratic evolutions: electronic trading, robo-advising, and user-friendly platforms like Robinhood and Acorn, to name a few.
A similar opportunity exists. What was once individually traded stocks and high fees prohibitive to the retail investor is the realm of private equity and illiquid growth—now separated by the iron curtain of Initial Public Offering (IPO). For those who can gain access to private equity (PE) markets, a bounty awaits. From 1996 to 2016, the average return of the S&P 500 was 8 percent as opposed to 12 percent in PE—and decreased volatility. For perspective, with a base investment of $10,000, the former would yield $49,267 while the latter would boast $108, 925 after a period of 20 years posting these returns. Additionally, 486 IPOs took place in 1998 as opposed to 159 in 2019, a decrease of 67 percent. Diversification is becoming increasingly difficult as the number of public companies shrinks.
Why does such a dramatic discrepancy persist? Between 1980 to 2015, the median time for a company backed by venture capital to IPO lasted roughly seven years, but since 2010 this interval has expanded to more than ten. In fact, the standard four year stock option vesting period originated from startups historically exiting within that same timeframe. The reasons for this new increase vary: the ability to raise more capital in private markets, high costs of regulatory compliance, mutual funds focusing primarily on large capitalizations, hostile pressures on public companies, and more.
As a result, many high-yielding companies experience their periods of critical growth outside the reach of retail investors. Scott Kupor, author of Secrets of Sandhill Road, posits this loose example: Microsoft went public in 1986 with a capitalization of $350 million, which has expanded to a market cap of $1.58 trillion—as of this writing, a 4,500x return in the public market. In 2012, Facebook debuted at $100 billion and now sits at $744 billion, a 7.44x public return. While it may be difficult to compare these scenarios directly, it illustrates the fact that the trend of start-ups staying private longer does so by experiencing gains at the expense of everyday retail investors who miss out on major economic growth in public markets.
The disfranchisement of the ordinary boils down to the SEC determining who is allowed to invest in PE. Currently, only accredited investors and large institutional firms can essentially have direct access to private markets. A U.S. accredited investor is generally defined as one being “sophisticated” with $1,000,000+ in net worth or $200,000 in annual income for the last two years. Thus, only the rich or institutionally robust may participate. Even for mutual funds, who profit by democratizing access to markets by pooling individual investments into a credibly large organization, can only dedicate 15% of their total fund to illiquid assets.
If the SEC were to tweak its rules—or an institution be creatively malleable—the implications would be profound. Equity crowdfunding is one stab, as permitted by the JOBS Act of 2011, although platforms like StartEngine facilitate investing only on an individual basis, or through self-directed IRAs, for retail investors—and directed mostly to risk-borne early-stage start-ups. While such structures provide a window into private markets, it is narrow. Only 1,400 entrepreneurs of 6 million U.S. businesses have tried it. Investing of this genre requires relatively time-intensive research, upfront skill, a lack of automatic diversification, and a potentially long period of “locked-up” wealth for ordinary investors.
StartEngine and equity crowdfunding are a foothold. But for a platform to be ultimately democratic, profitable, and truly revolutionary requires elements of passivity, automation, and a dependable schedule. A world of refined SEC guidelines—like easing restraints for target date funds and expanding the definition of accredited investors—would catalyze its emergence. A tool that could mesh these ingredients while tapping a mature pre-IPO in a period of critical growth would mark a key pivot in both finance and democracy.