The Takeaway
Private companies are difficult to value because quality data is scarce. Investors rely on third-party valuation techniques, which suffer from a lack of timely data or the subjectivity of human inputs.
We estimate the mark-to-model valuations of private companies based on a statistical model that leverages past deals as well as contemporaneous private- and public-company comparable data.
Leveraging our mark-to-model valuations, we have created a first-of-its-kind family of indexes, the Morningstar PitchBook Global Unicorn Indexes, that bring transparency to the late-stage venture capital market.
Private companies have grown to occupy a considerable share of institutional portfolios over the past decade, and many retail investors are beginning to gain exposure to private firms through managed investment products. The asset class has expanded considerably and offers exposure to a range of industries and geographies. Institutional investors—pension funds, insurance companies, endowments, and foundations—have increased allocations to private markets in the hunt for higher returns and to diversify away from public markets. As more venture capital-backed companies remain private longer, the opportunity set and access points for investors continue to evolve. Over time, we anticipate more investor portfolios to regularly contain both public and private equities.
Investor interest, particularly from the retail segment, is not without merit—venture capital investment is known for remarkable long-term returns. However, measuring the unrealized returns and potential risks of these businesses is easier said than done. Private fundraising rounds can be few and far between, making prices hard to determine. For most retail investors, portfolio construction relies on grounded capital markets assumptions that reflect the potential interplay between various assets. The addition of private company exposure into a portfolio may well be a boon to long-term accumulation. But these new exposures raise challenges for wealth advisors to identify appropriate allocations to meet investor goals. Without the proper tools, advisors may overstate or understate the rewards and risks in client portfolios that come from allocations to private markets.
One mark of the rapid growth of private markets is the burgeoning number of unicorns, or venture capital-backed companies valued at $1 billion or more. The ranks of unicorns now exceed 1,300 globally and have a collective value of roughly $4.5 trillion. But the paucity of market benchmarks limits the ability of investors to understand the behavior and risks of private markets. Our mark-to-model approach allows for the creation of dynamic performance series to inform investors of market trends, allow better asset-allocation decisions, and serve as the basis for further benchmark development. The model uses three factors—past deals, comparable private company deals, and comparable public market valuations—to create implied mark-to-model valuations. Testing of the model conducted for the period between early 2021 and mid-2022 resulted in appropriate identification of 78% of major up and down rounds in deals for private companies.
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