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The ongoing lack of exits in the current economic environment has created challenges for investors of all stripes—but in the case of small and medium firms, it is yet another barrier preventing parity with their larger counterparts. A growing divide between large and small investors has only become more pronounced in recent years, trending towards increasingly large deal sizes.

A heightened emphasis on mega-deals meeting or exceeding $1 billion crowd out small and medium firms, which don’t have the resources to fall back on during a challenging economic period or a proven history of enduring similar circumstances. Though small and mid-size investors have historically avoided the private markets, incorporating them into their strategy could help these investors not only navigate the current market environment, but also narrow the gap between themselves and larger firms.

Advantages of small and medium size investors

Though small and medium size investors are often acutely aware of the strengths of larger firms—strengths much of the market is structured around—they also possess their own unique set of advantages that sometimes go overlooked.

Small and medium size investors are agile and not beholden to the same number of approvals and internal hurdles when looking to looking to execute on their strategy. As such, their accurate and timely decision-making can be rewarded if they’re among the first to act after an opportunity arises—even if they can’t allocate the same amount of capital towards it.

Smaller investors benefit from having easier communication, reinforcing faster execution, which is often the outcome of greater team cohesion and alignment on decisions. A smaller team increases the likelihood of consensus and cuts down on time that would otherwise be spent debating potential courses of action.

Smaller firms possess greater technological readiness than their larger counterparts, meaning they’re more open to adopting new tech as part of their workflow. This often allows them to work smarter—not harder—and readily switch to whatever tech best suits their needs, since they don’t need to worry about onboarding big segments of an organization.

Small and medium size investors can create more personalized connections with clients or focus on a specific niche, which can be a valuable differentiator. By having the freedom to focus on a specific sector or investment type, instead being pressured to generalize like at a larger firm, these smaller investors can position themselves as experts, earning them the favor of specific clients.

Now that we’ve outlined the unique strengths of small and medium size investors, let’s look at how those strengths can be applied in the current market environment.

Don’t try to change course too quickly

It may seem strange that our first piece of advice is to not change anything (yet), but hear us out. Though it may feel like larger firms are able to conduct better research, have more experienced investors, and are better resourced, small and medium size investors shouldn’t necessarily try to imitate their strategies and would be well-advised to trust their own instincts.

In studies conducted by Affiliated Managers Group in 2020, results suggested that small investors—like boutique asset managers—made better decisions in volatile periods than their larger counterparts. According to these studies, boutiques had 1.2% higher average net annual returns in volatile periods compared to non-boutique asset managers, and performed better outside of volatile conditions by 0.62%.

Though these figures aren’t enough to prove that smaller firms are “better” and don’t account for why LPs gravitate towards large firms, they do potentially shed light on the dynamic between small and large investors. The fact that small firms were able to score higher suggests that although larger firms have the resources to go wider on sector coverage, smaller firms have the unique option of being able to go deeper into specific sectors without the pressure of having to monitor the whole market. Being able to sustain a specific niche and dedicating all their resources to covering it better than a large investor gives small and medium size firms a unique form of leverage and a potential avenue to stand out to clients.

Look to private market investments to fill gaps in your portfolio

The private markets are often regarded as the territory of larger and more experienced firms but, if handled responsibly, they can also be used to great effect by small and medium size investors. The main benefit of pursuing private market investments is the range and exclusivity they offer. By venturing into the private market, small and medium size firms can open the doors to various industries and markets they can’t find through the public investments.

Stepping into the private market not only gives small and medium size investors an advantage over other similar-sized firms unwilling to pursue these types of investments, but also a chance to apply their expertise in a field that has previously gone uncontested. In other words, though there have no doubt been small and medium size investors that could have capitalized on private market developments, their avoidance of this investment type has left only larger firms to claim these opportunities.

It is worth noting that the historic perception of private markets being unforgiving for small investors isn’t an entirely unfounded belief—many cite the lack of liquidity as a major concern, especially in the case of less experienced firms that expect to make mistakes and seek out the flexibility that comes with greater liquidity. Though this is a real concern, it may well be the very thing holding these investors back from achieving an optimized portfolio. The diversification offered through private market investments can indeed help insulate investors against market uncertainty and position them to invest in companies they believe can weather the current environment.

Rethink illiquid assets

Lack of liquidity is the largest barrier between smaller investors and the private market, but surprisingly, this characteristic may actually work to their benefit. Like the broader private market they belong to, illiquid assets have been perceived as exclusively for larger, more experienced firms, since they have more capital and therefore are less concerned with lockup periods and the inability to access their funds.

Seeing as private market assets with a lockup are forced to remain static, small and medium firms lose the means and the temptation, so to speak, to chase different market trends. Were these private market assets more liquid, new investors might try to sell their shares to perpetually act on new speculation. Being unable to, however, not only makes a smaller firm consider their initial private investment more carefully—since they can’t be rid of it—but also gives them time to internalize market patterns for when they can sell their shares post-lockup.

Additionally, though the private market is strongly associated with illiquidity, there have recently been more products that allow investors to access these sectors and clients while still retaining liquidity.

Find gateway investments suited to your strategy

Small and medium size investors have historically been barred from alternative assets, both because of regulatory conditions and fit, but in recent years, we’ve seen more avenues for smaller firms to become involved. These gateway investments take the form of products like real estate investment trusts (REITs) for real estate, 40 Act interval funds for hedge funds and so on, which provide a way to invest in otherwise inaccessible alternative assets.

Another factor worth noting about these investment products is their resemblance to something a small or medium size investor would already know—for example, the master limited partnership, which is an introductory product for commodities, functions much like a common stock, as do REITs for real estate. By the same token, the 40 Act interval funds for hedge funds closely resembles a mutual fund. Through engaging with these products, small and medium investors can not only break into an investment type that was previously inaccessible to them, but do so in a way that allows them to carry over their experience and apply it to these alternative assets.

Lean on technology to better understand the private market

Though larger investors have been proven throughout to have more resources and greater access to investments, small and medium investors are more flexible in being able to integrate things like third party support and new technology.

One technology that is especially promising for firms looking to enter the private market is PitchBook’s VC Exit Predictor, a platform feature that helps investors identify and connect with venture-backed companies positioned to exit. Designed by PitchBook Institutional Research Group, it pairs industry-leading platform data and research with AI and machine learning functionality to determine exit probability, exit type, and even projected return performance using proprietary Opportunity Score metrics based on historic data.

This new VC Exit Predictor functionality from PitchBook is a powerful resource for any VC investor, but we believe it is especially useful to smaller investors, helping to tip the scales between themselves and larger firms.

Leveraging the VC Exit Predictor represents an enormous timesaving measure for smaller-scale teams, significantly cutting time spent doing platform research manually. This similarly allows small and medium size investors to overcome the resource and research gap with larger firms, synthesizing data and producing insights only possible with PitchBook’s unique data set and technology.

Finally, the VC Exit Predictor helps small and medium size investors to make the most of their limited investment capital by focusing on companies that are likely to exit thus yield returns, allowing them to remove uncertainty and continue to build momentum.

More on the VC Exit Predictor

What is the VC Exit Predictor?

PitchBook’s VC Exit Predictor is a machine learning algorithm that predicts a venture-backed company's likelihood of exiting with 74% accuracy. It uses classification models to predict the probability of acquisition, going public, or experiencing a traditional exit. The Opportunity Score uses these predictions and historical average returns to calculate an estimated IRR, shown as a percentile.

How are VC exit predictions generated?

To qualify for the VC Exit Predictor, a company must have received at least two rounds of venture financing deals, with at least one deal occurring within the last six years. The algorithm uses data points such as deal activity, active investors, company performance indicators, and market positioning to generate exit predictions.

What’s the difference between Exit Type Probabilities and the Opportunity Score?

Exit Type Probabilities indicate the likelihood of a venture-backed company experiencing an IPO or M&A deal, while the Opportunity Score represents a simple expected return on investment. The Opportunity Score is shown as a percentile to provide a quantitative approach to compare a potential rate of return from investing in that company relative to other companies.