Tech Money Sends Funds on the Hunt for Unicorns

By DAVID GELLES and CONOR DOUGHERTY   MARCH 22, 2015

The retirement accounts of millions of Americans have long contained shares of stalwart companies like General Electric, Ford and Coca-Cola. Today, they are likely to include riskier private stocks from Silicon Valley start-ups like Uber, Airbnb and Pinterest.

Big money managers including Fidelity Investments, T. Rowe Price and BlackRock have all struck deals worth billions of dollars to acquire shares of these private companies that are then pooled into mutual funds that go into the 401(k)’s and individual retirement accounts of many Americans. With private tech companies growing faster than companies on the stock market, the money managers are aiming to get a piece of the action.

Fidelity’s Contrafund includes $204 million in Pinterest shares, $162 million in Uber shares, and $24 million in Airbnb shares. Over all, there were 29 deals last year in which a mutual fund bought into a private company, and they were worth a collective $4.7 billion, according to CB Insights. That was up from six such deals, worth a combined $296 million, in 2012. T. Rowe Price was the most active big investor, making 17 investments in private tech companies.

Because these tech companies are not required to issue financial reports and are not traded on traditional exchanges, they are the sort of speculative investments not normally found in retirement accounts. Increasingly, however, investors are betting that these companies will be bought or go public at prices that exceed their latest funding rounds, a prospect that is anything but guaranteed.

“I think it goes beyond what mutual funds were set up to do,” said Leonard Rosenthal, a professor of finance at Bentley University in Waltham, Mass. “It’s great for the portfolio manager, but it’s not necessarily in the interest of the shareholders of the fund. If investors are looking for a portfolio of risky securities, there are plenty of stocks to trade in the public market.”

The dilemma for big fund managers is that fast-growing technology companies are so reluctant to sell private stock to the public that there is now a term — “unicorns,” reflecting just how wonderful and magical they are considered to be — for the dozens of private firms worth $1 billion or more. Several, including the ride-hailing company Uber, the room rental site Airbnb and the digital scrapbook Pinterest are worth more than $10 billion.Those lofty valuations, combined with the eagerness investors show in bidding them up, have created a shadowy market for private stock issued to tech companies’ early investors and employees. For the last few years, mutual funds have sat on the sidelines.

Now, they are racing to get in. “More and more, the big lopsided growth is happening away from the public markets,” said Andrew Boyd, head of global capital equity markets at Fidelity.

Take Uber, which was valued around $40 billion in its latest round of financing, up from $3.5 billion in mid-2013. That is more than 1,000 percent growth, compared with 28 percent for the Standard & Poor’s 500-stock index over the same time period.Yet the many billions of dollars in new wealth being created by private tech companies is largely being funneled to a handful of entrepreneurs, venture capitalists and early employees. For the most part, the broader public is left out.

“There’s a huge amount of wealth creation happening, and a very narrow set of people are benefiting from it financially,” said Scott Kupor, who, as a managing partner and chief operating officer at the venture capital firm Andreessen Horowitz — a major investor in many of the unicorns — is among that narrow set.

Big money managers argue that they are broadening this pool by giving everyday investors access to tech’s money machine. And despite the many risks, they say they believe the companies they are buying into are big enough and established enough that the investments are not all that much riskier than those in public companies of a similar size.

“We’re nowhere near the two guys in the garage,” said Mr. Boyd of Fidelity. “We are near companies with hundreds of employees and billions of dollars in revenue.”

And while the dollar figures being invested are large, managers say individual holdings of any one stock make up a small part of big mutual funds, making the investments less risky. Fidelity’s Uber stock, for example, represents less than 1 percent of each fund’s total holdings.

For investors, of course, that is a mixed blessing: Their retirement stays safe, but when a company like Uber appreciates 1,000 percent, they get only a sliver of the profits.

Private technology stocks are not new, but there have never been so many, and they were never this big. In the 1990s, when going public was more common, company founders would sometimes pool shares into what amounted to a kind of exchange fund that allowed them to swap their own equity for shares in other start-ups.

But for anyone to see a significant return, a company had to be bought or go public, which helps explain why ’90s tech firms were so eager to have initial public offerings.

In the late 2000s, as companies started to stay private longer, founders and venture capitalists began to look for ways to sell their shares for cash, opening the door for employees to do the same.

Then came Facebook, whose private valuation went as high as $100 billion, creating a vast market for private shares. So many people, from big mutual funds to smaller investors, got their hands on so many shares that Facebook was pressured to go public earlier than it otherwise might have.

That example has prompted many companies to try to limit how many shareholders they take in. And investors have enabled those efforts by writing lots of big checks, allowing companies to avoid the scrutiny of a public offering for many years longer than would have been possible a decade ago.

As is characteristic of pretty much every investment boom, what began as a select few has grown so large that the earliest and biggest investors are finding innumerable ways to sell their shares to the masses of outsiders hungry to get in.

The interest in private tech companies has become frenzied enough that the market for private shares has moved well beyond big institutional investors to investors with a few thousand dollars. Take SharesPost, a broker for private shares, which last year started the SharesPost 100 fund, allowing anyone with $2,500 to buy into what amounts to a mutual fund made of private shares in companies like Jawbone and DocuSign.

This comes with plenty of risk. For starters, the fund is made up of shares that are illiquid, meaning they are hard to move under normal circumstances and nearly impossible to move when there is even a whiff of bad news about the company. Furthermore, many of the larger and early-stage investors have perks that no normal person can get. Preferred investors, for instance, are often first in line to get their money back, meaning that if the company is liquidated, they will be paid before other investors.

And no matter if investors are big or small, there is still no guarantee that private start-ups will be public market stars.

“With some of these companies,” said Jay Ritter, a professor of finance at the University of Florida, “there’s no guarantee that they will go public.”

A version of this article appears in print on March 23, 2015, on page B1 of the New York edition with the headline: Tech Money Sends Funds on the Hunt for Unicorns.

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