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Behind closed doors: investment platforms vs. proprietary dealflow

A year ago I wrote a post titled “Proprietary dealflow isn’t dead and for good reason”. But with the rapid emergence of online investment platforms, how much is left of the rationale for keeping an investment opportunity behind closed doors?

Too many investors: the winner’s curse  
According to conventional wisdom, a hyper competitive auction-style process may drive up the asking price so much that only the last “fool” will invest. But what if investment platforms make it possible to invest a smaller amount in a single deal? Then, total demand in $ terms does not change that much, so the bidding price is much less affected. Even if the price would go up somewhat, investors receive compensation in the form of diversification: they get to make more smaller bets, instead of fewer bigger bets (just like public market investing).

Compensation for time spent on due diligence
Another underlying argument for keeping a deal private, is that due diligence is a time-consuming and costly process. To justify spending time on an investment opportunity, investors generally like to have some degree of upfront certainty that they can invest if they decide to make an offer. But what if more company transparency and better online due diligence tools, can make this process less time consuming? And if an investment platform allows for smaller bets on a single deal, it would justify doing less due diligence on a single deal (again, comparable to public market investing).

What really drives private equity and venture capital returns?
Investment returns for funds with a 3-5 year investment horizon are basically driven by: the price paid at entry, and the price at exit (plus some dividends in between). Deal access (networking) will become less of a differentiator, and also price paid (negotiation) increasingly will become market-driven. In the end, investment performance will be mainly driven by picking the right deals: making better “yes/no” investment decisions than others, but based on the same information access (once again, like stock picking).

At we let the client decide which investors they give dataroom access. So it is up to them to cast the net wide or narrow. But the market is noticeably moving into the direction of wider not narrower. Investment platforms are an unstoppable force, that will require a slightly different mind-set from professional investors. The main thing holding back an even more rapid advance of investment platforms right now is the problem of adverse selection, which is ultimately a problem of not enough transparency. Innovation can ultimately solve this. I plan to write another post about this soon.

Also see: Proprietary deal-flow isn’t dead and for good reason