In this edition of our newsletter, we will dissect the distinct dimensions of private and public investments in growth companies, focusing on the vibrant landscapes of Germany and Scandinavia. Unveiling the strategic fit of investor groups with specific market segments, we explore size, time frames, and personal objectives. Amid this exploration, we navigate prevailing trends and market climates across industries, considering the far-reaching implications of recent changes.

Private Investments

Private funding for growth companies, which we will refer to as nanocaps, is mainly dominated by business angels and venture capitalists, which engage from the pre-seed stage onwards. In Germany, 68% of nanocaps sought funding in 2022. Among those seeking external capital beyond government aid, 46% favored business angels, 44% chose venture capitalists, and 43% considered strategic investors[1]. Given that most companies opt for a blend of funding sources, private funding proves indispensable for nanocap development.

Business Angels typically enter the investment landscape at the pre-seed stage of nanocaps, maintaining their involvement as the company progresses. This early entry point means companies have less time to establish themselves, potentially leading to greater fluctuations in their development trajectory. Consequently, such investments carry a slightly higher degree of risk and might necessitate a longer timeframe for returns to materialize. Yet, the advantage lies in the lower capital requirement at this stage. On average, angels commit around 25,000 to 100,000 USD, with some investments even surpassing this range[2].

In contrast, Venture Capital (VC), a form of private equity funding, aligns with high-risk investments in growing enterprises. It’s a favored choice for small companies with the potential for above-average returns, often due to imminent expansion or scaling opportunities. Generally, VCs yield more substantial returns in slightly later stages when companies have had time to establish themselves, thus mitigating certain risks. However, it’s important to note that statistically, experts estimate that only around one in ten VC investments ultimately yield above-average returns.

In general, private markets are known to offer higher returns compared to their public counterpart, especially in the long run, which makes it more attractive to individual investors[3]. Looking at the entry barriers, private investors are often required to put down bigger funds and might even need an accreditation. That could entail a net worth higher than one million USD, or an annual income of more than 200.000 USD, depending on the country of residence and which market they want to enter[4]. Conversely, privately managed firms are not compelled to disclose stock-related information, granting them greater managerial independence[5]. This autonomy becomes particularly attractive to private equity funds, which frequently target substantial shares in private enterprises, streamlining management, especially during expansion phases[6]. Acquiring a majority stake enables investors to become more closely involved in the company’s management, an option that might not always be feasible in publicly traded firms, contingent on prevailing investment norms within a given country.

Despite the burgeoning demand on the company’s front, a concerning downward trajectory has been observed concerning private investors. This phenomenon can likely be attributed to the escalating inflation rates and intricate global political landscape. As a response to these unsettling factors, numerous private investors have veered away from ventures deemed high-risk. Instead, they are opting to steadfastly retain their existing holdings, aiming to continue reaping benefits from their established investments.

The confluence of inflated valuations and surging interest rates has inevitably inflated share prices, casting a pall over the prospect of potential investors. This unfortunate confluence has spurred what is commonly referred to as a “Flight to Quality” phenomenon[7]. In essence, investors are redirecting their focus towards the most promising start-ups, those positioned to receive funding at valuations that harmonize with the prevailing economic climate — a scenario more grounded and pragmatic. Regrettably, this shift has resulted in a scenario where only a fraction of innovative ideas garner the necessary support, leaving many visionary founders in the lurch.

Nonetheless, there’s a silver lining poised to emerge once economic stability takes hold and investor confidence experiences a resurgence. A notable example of this trend can be seen in the early-stage funding landscape across Europe. A stark decline in early-stage funding, plummeting by half, was witnessed, with a stark drop from 10 billion USD in funding during Q4 2021 to a mere 5 billion USD in Q4 2022[8]. As witnessed in Q1 2023, the rate of decline has flattened, with only a 7% reduction in funds being reported during that time. As the downward trend seems to have reached a plateau, an increase in funding can be anticipated over the next months[9]. Encouragingly, signs of an upward trajectory have begun to materialize in the US, evidenced by a modest incline detected in Q2 2023 compared to the previous quarter[10].

Public Investments

Investing in public companies involves purchasing ownership shares of businesses that are traded on stock exchanges. This offers investors a stake in the company’s ownership and the potential for financial gains as the company grows. Public companies often choose this route to raise funds for their growth and operations. Through investing, individuals open avenues to reap dividends, witness their investment appreciate over time, and even wield influence in vital company decisions through voting rights.

The timing of public market entries varies by region, leading to certain limitations on publicly investable companies. A comparison between Germany and Scandinavia illustrates this point. Notably, there exists a significant disparity in the timeframes for companies to undergo their initial public offerings (IPOs). German companies tend to navigate their early stages privately, while Scandinavian stock markets exhibit a greater capacity to accommodate early-stage investments. This is exemplified by the fact that IPOs are both feasible and customary even during seed investment rounds in Scandinavia.

This dynamic has contributed to Sweden’s thriving startup ecosystem, boasting a valuation exceeding 63 billion USD at the outset of 2023, in stark contrast to the average valuation of 28.6 billion USD per other country globally[11]. Examining the sectors that thrive within the Scandinavian ecosystem, a distinct emphasis emerges on technology-driven products and services, notably within Clean Tech and Life Science domains. This alignment reflects the escalating call for sustainable solutions spanning industries, buoyed by the implementation of energy efficiency directives and emission regulations. Notably, investors are gravitating towards impact-driven prospects, aligning seamlessly with Europe’s and even global environmental and sustainable mandates. A remarkable surge is reported in venture capital for impact-centric start-ups, marking an astounding increase of over 250% between 2020 and 2022[12].

In Scandinavia, we see a significant personal interest of public investors in the progress of nanocaps, much alike we see among private investors. Also, on the other end, listed nanocaps prioritize meticulous investor management and actively seek advice from their investor base. This approach holds particular significance during the early phases when a company’s foundation is delicate, and roadmaps are subject to frequent adjustments.

Similar to private investments, the risk associated with public investments can vary based on the developmental stage they are intended to bolster, adhering to the widely recognized principle of “high-risk, high-reward.” Although Scandinavia is more equipped to support nanocaps entering the public market, early-stage investments still bare higher risks than late-stage investments. Overall, due to the pressure to deliver short-term results public companies face, the market operates on a rather short-term prospect[13].

The public market boasts higher liquidity, enabling investments to be traded daily. This accessibility, coupled with the broader reach to a diverse community of potential investors, fosters extensive participation in investment activities. Nonetheless, the disclosure of financial data by listed companies to the public is a mandatory requirement, ensuring transparency and facilitating comprehensive comparisons among these firms in accordance with IPO regulations[14]. In contrast, the absence of such official regulations in the private sphere can lead certain investors to perceive public investments as more manageable and transparent.

In addition, public investments offer the potential to bridge international markets. This not only makes local retail investments possible but also empowers investors to explore opportunities on a global scale. This is made even more accessible through modern online platforms and neobrokers, which allow for easy tracking and trading from home. So, even if nanocaps aren’t listed in your home country, you can still invest in them by expanding your search. In terms of impact investing, this cross-border engagement in public markets could also contribute positively to our environment, providing extra backing for ESG-focused start-ups.

Conclusion

In essence, both private and public markets present distinct advantages and drawbacks, contingent on an investor’s commitment to their stocks and the company’s growth trajectory. Additionally, the extent of one’s background knowledge and confidence can influence the choice of investment avenue.

Private markets inherently carry more risk than their public counterparts, primarily due to their common association with early-stage business funding. For the same reason, private investments are an attractive avenue for those inclined towards long-term commitments, seeking an encompassing view of nanocap growth and a hands-on approach by acquiring majority stakes. In contrast, public markets often cater to short-term investment preferences, offering regular returns. Public investments may also seem more secure owing to stringent transparency regulations that facilitate effortless comparisons, whereas private investments necessitate in-depth company research. However, these regulations mandate more active stock maintenance compared to private funds, often requiring participation in corporate actions.

Conversely, private investments demand larger capital outlays and a higher degree of preparation, potentially even requiring an appraisal. Such requisites tend to attract investors with a more extensive financial acumen. Depending on your available resources and time constraints, you might discover a natural alignment with one of these market options. You might also find camaraderie in a business angel network that aligns with your values and focuses on growth companies that resonate with your objectives. Ultimately, there’s no definitive right or wrong choice; what matters most is making well-informed decisions as you diversify your investment portfolio.

We trust that this information has provided you with valuable insights. Please feel free to reach out for further discussions or information.

[1] „Deutscher Startup Monitor 2022: Deutsche Startups trotz zunehmender Unsicherheit robust“, Berlin, Sep. 29^th 2022, startupverband.de, Deutscher Startup Monitor 2022: Startups in Deutschland (startupverband.de)

[2] “Can I be an angel investor?”, P. Villanova, Aug. 07^th 2023, yahoo.finance, Can I Be an Angel Investor? (yahoo.com)

[3] “Public Vs. private Assets: The Big Switch, The pendulum has swung in favor of private—will it swing back?”, H. MacArthur, R. Burack, C. D. Vusser, K. Yang, B. Rainey, Feb 25^th 2019, Bain & Company, Public Vs. Private Assets: The Big Switch | Bain & Company

[4]“Private Investment Fund: Non-public Investments Like Hedge Funds”, J. Chen, Oct. 17 2020, Investopedia, Private Investment Fund: Non-public Investments Like Hedge Funds (investopedia.com)

[5] “Private vs. Public Equity: Difference and Comparison”, C. Yadav, June 11^th, 2023, askanything, Private vs Public Equity: Difference and Comparison (askanydifference.com)

[6] „Verstehen Sie die Bilanzierung von Private-Equity-Fonds?“, June 24^th 2021, KamilTaylan Blog Finanzielle Enzyklopädie, Verstehen Sie die Bilanzierung von Private-Equity-Fonds – KamilTaylan.blog

[7] “Venture Capital Investment Market Share, Trends, Growth Drivers, Revenue, Scope, Challenges, Opportunities and Future Competition Till 2033: SPER Market Research”, Jul. 2023, SPER Market Research, 1 new message (sperresearch.com)

[8] “Europe Venture Fell In The Second Half Of 2022, But Not As Steeply As Other Regions”, G. Teare, Jan. 12^th, 2023, crunchbase.de, Europe Venture Fell In The Second Half Of 2022, But Not As Steeply As Other Regions (crunchbase.com)

[9] “European VC Funding Drops 66% As Seed Takes A Hit, US Investors Pull Back”, K. Vedantam, April 11th 2023, Crunchbase news, European VC Funding Drops 66% As Seed Takes A Hit, US Investors Pull Back (crunchbase.com)

[10] “State of Pre-Seed Fundraising: Q2 2023, P. Walker, Aug. 11^th, 2023, Carta.de, State of pre-seed fundraising: Q2 2023 | Carta

[11] “Top Swedish Startups to Watch in 2023”, A. Fybish, Jan. 13^th 2023, Startup Stash, Top Swedish Startups to Watch in 2023 – Startup Stash

[12] “How Nordic Investors Invest, According to Nordic Investors”, Y. Tved, Sep. 27^th 2023, Sifted.com, How Nordic investors invest, according to Nordic investors | Sifted

[13] “Private vs. Public Equity: Differences and Comparison”, C. Yadav, June 11^th 2023, Askanydifference.com ,Private vs Public Equity: Difference and Comparison (askanydifference.com)

[14] “Private vs. Public Equity: Differences and Comparison”, C. Yadav, June 11^th 2023, Askanydifference.com ,Private vs Public Equity: Difference and Comparison (askanydifference.com)