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Mutual Fund Investments in Private Firms

April 22, 2022

The lines between private and public listing status have become increasingly blurred.

The number of publicly listed companies has decreased. Strikingly, at the same time, private companies are increasingly raising funding from investors who traditionally focused only on public companies. In this study, we strive to provide systematic evidence on the time-series trends in mutual funds’ investments in private firms. We then estimate the effects of this funding on the underlying companies, including the extent to which these mutual fund investments enable companies to stay private longer.

We document a dramatic increase in mutual funds’ tendency to invest in private venture-capital backed firms.

We study the investment behaviors of 16 mutual fund families, including the largest families such as Vanguard, Fidelity, and T Rowe Price. Between 1995 and 2000, less than 15 mutual funds had investments in private, venture-capital backed firms. This had increased to over 90 by 2015. Analogously, the aggregate valuation of mutual funds’ investments in these private companies increased from $16 million to over $8 billion over this period. Thirty-eight percent of the IPOs by VC-backed firms in 2016 had received funding from this set of mutual funds prior to the IPO. Moreover, mutual funds provide a substantial amount of capital to the firms in which they invest: the funds provide an average 38% of the total financing raised (measured across funding rounds with mutual fund participation) over the 2011–2016 period.

Mutual fund participation has a positive effect on total funds raised.

The investments by mutual funds provide companies with more capital than they would have raised solely from the venture capitalists. We find that most mutual fund investments represent purchases of primary shares, rather than purchases from existing shareholders. Moreover, the capital provided by mutual funds appears to be incremental to that provided by venture capitalists.

We find evidence of funds relying on the certification effects of intermediaries.

Mutual funds are more likely to invest in companies backed by higher quality VCs. Consistent with mutual funds focusing on companies that have already demonstrated some level of success, the companies with such investment are significantly less likely to fail and are more likely to go public via an IPO. Interestingly, these companies are less likely to be acquired, compared to companies without mutual fund investment.

Mutual fund participation enables companies to stay private significantly longer.

Mutual fund investment significantly increases the ability of a company to stay private longer. The ability to stay private longer provides companies with added flexibility, including for example lower regulatory burdens and less pressure from public markets.

Mutual funds have benefited by investing in private firms.

Mutual funds have become increasingly likely to supply capital to private firms as a source of higher potential returns, greater diversification, and increased IPO allocations. The decrease in the number of public firms has decreased mutual funds’ investment opportunities, making it more difficult for them to differentiate their portfolios from those of other funds and to identify sources of positive abnormal returns. Over our sample period, mutual funds earned 1.7 – 2.6 times more in their private firm investments than in the overall market index.

These changing dynamics affect multiple parties.

Regulators who are faced with policies based on a strict line between public and private listing status will need to reexamine these policies. These changing dynamics also affect firms who are faced with potential changes in both sources of capital and costs of capital, and investors who face changes in their investment opportunity set.

Key takeaways:

  • If you are an investor (mutual funds): The opportunity to invest in private firms has provided mutual funds with positive abnormal returns over recent past time periods. While we cannot say whether this will continue to be the case in the future, our findings suggest benefits to mutual funds of evaluating this asset class.
  • If you are a VC: Our findings suggest that there are benefits to developing relationships with mutual funds. Co-investing with mutual funds provides benefits to private companies, and as such can potentially contribute to better portfolio outcomes.
  • If you are with a private company: Funding from mutual funds enables a company to raise more money and to stay private longer. This added flexibility has value along multiple dimensions.
  • If you are a regulator: The lines between private and public status are becoming increasingly blurred. For a regulator tasked with both protecting investors and facilitating capital formation, our findings raise many questions. If individual investors are increasingly investing in private companies through mutual funds, should it be easier for individuals to also invest more directly in private companies? If private companies are staying private longer by obtaining capital from entities such as mutual funds, should these companies be subject to increased disclosure requirements, such as those pertaining to public companies? We hope our findings contribute toward a thoughtful conversation on these issues.

The complete paper was published in the Journal of Financial Economics.
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