Growing retail investor interest in private markets

The "retailization of alternatives" is a financial trend that refers to the increasing availability of private market (alternative) investments to retail investors—that is, non-institutional investors with less than $30 million in assets. Interest in private markets has surged in recent years from asset and wealth managers, including family offices, as the result of demographic shifts and changing investor preferences. For entrepreneurs and private companies, the heightened interest from retail investors could have an impact on capital-raising strategies, valuations, governance, taxes and other areas.

Taking on retail investor capital can be different from working with institutional investors. And without the necessary capabilities, it may become a complicated distraction.

Here are six considerations about retail investor interest in private markets and their potential implications for entrepreneurs and private companies.

1. Potential new source of funding

Traditionally, retail investor capital has flowed to private companies through investment in private funds and venture capital.

However, in recent years crowdfunding platforms protected under the SEC’s Regulation A have enabled many start-ups and private companies to raise billions of dollars from everyday Americans. The measure allows businesses to annually raise up to $75 million while complying with lighter-touch rules than a traditional initial public offering [IPO].

The democratization of private markets could allow private companies to diversify their funding sources, complimenting the use of traditional venture capital and private equity, which come with varying control measures and return expectations. By tapping into retail investor capital, many companies may be able to achieve a more balanced and flexible funding structure.

Having a strong strategy to attract and manage retail investors is not only a way to grow your business today, but it can also help with your exit readiness, which has increasingly come into focus as many companies prepare for potential sales to financial sponsors or strategic buyers, and even the possibility of an IPO exit.

2. Increased transparency of reporting, governance and controls

Accepting retail capital can heighten the need for private companies to be more transparent than under the traditional private investing model, where there's a "blocker" corporation that acts as a middleman between the investor and the company.

Retail investors usually demand greater transparency, and private companies may need to adopt more rigorous reporting standards that are akin to those of public companies. This could include regular financial disclosures, performance updates and adherence to stricter governance frameworks.

With retail investors, regulatory bodies are likely to impose stricter compliance and reporting requirements. While this may increase administrative burdens and costs, it also helps build trust and credibility with a broader investor base.

Raising capital from a wider investor base can also lead to dilution of control for existing owners and management, necessitating changes in governance structures and decision-making processes.

3. New tax and audit considerations

Private companies interested in attracting retail capital should be prepared to face new complexities and costs associated with managing a diverse capitalization table. This can be important to navigate as companies grant more of the profits to investors, which can significantly increase tax and audit fees.

The usual retail investor may also have higher service expectations than more traditional private investors, such as providing guidance on tax filings. You may want to proactively revisit your private company’s legal entity and investment structure, as there could be ways to simplify their tax reporting to more easily meet retail investors' expectations and lay the groundwork for ongoing relationships.

4. Impact on valuations

The entry of retail investors can lead to higher valuations, driven by increased demand for shares. Paradoxically, this shift helps introduce potential volatility. Volatility could affect employee compensation tied to company valuations, such as stock options or profit interests, and potentially lead to decreased valuations if retail investors are unwilling to pay higher share prices.

There are many challenges for companies in managing these dynamics and your company’s leaders need to carefully consider them before accepting investment. Prepare by deploying reliable financial forecasting and valuation models. Work to develop reliable risk management frameworks, including scenario analysis, stress testing, and sensitivity analysis to anticipate and help mitigate risks associated with fluctuating valuations.

5. Greater liquidity demands

Retail investors have varying needs for liquidity and those with higher liquidity constraints will gravitate toward investments with liquid structures. This may help drive more secondary transactions that can have accounting, reporting and tax consequences for both investors and the company. You may need reliable liquidity reporting when targeting retail investors, as retail investment products may also have a subscription and redemption model that requires managing liquidity and reporting for investors.

In addition, educate retail investors about your company, and provide clear and easily accessible information about liquidity.

6. Need for investor relations function

Managing a larger and more diverse group of investors requires enhanced investor relations strategies that include effective communication channels and teams dedicated to keeping retail investors informed and engaged. This effort confirms that investor expectations are managed, and any potential issues are addressed proactively.

You should also manage the inquiries and needs of retail investors, who may be less sophisticated on certain financial matters and have more questions about their investments.