When CNBC editors finished compiling the Disruptor Top 50 list for this year, there was one big surprise. Thirteen of the 50 start-ups on the list had a common investor: Fidelity Investments, the mutual fund giant. Among them Uber (CNBC Disruptor No.1); Airbnb (No. 2); Snapchat (No. 16); Oscar (No. 17) and Spotify (No. 25).
You might not think of a mutual fund as an entity that would take the risk of investing in technology start-ups, but Fidelity has been putting money into private companies for years, said Andrew Boyd, head of global equity capital markets, who oversees private investment for Fidelity. In fact, he said, Fidelity was a pre-IPO investor in Facebook.
TechCrunch, a site that tracks technology-oriented venture capital investments, lists 50 active investments by Fidelity, including Uber, Airbnb, 23andMe, Snapchat, Spotify, SpaceX and Pinterest, among others, in its CrunchBase database. Fortune has identified investments in biotech and in consumer businesses, like Blue Bottle Coffee and electronic cigarette maker NJOY.
As CNBC has reported, Fidelity is not the only mutual fund company betting on hot technology start-ups. BlackRock, Janus, Wellington Management and T. Rowe Price have all invested in private companies.
Fidelity's Boyd, who declined to discuss specific investments, said he looks for late-stage start-ups that are preparing to go public and that promise to be dominant players. "What we are trying to do is find the next great companies," he said. "We are trying to find good investments for our customers — long-term winners." The actual investors are individual fund managers within Fidelity's panoply of funds, such as its Blue Chip Growth Fund, which has invested.
The focus on long-term is important in Fidelity's strategy. Unlike venture capitalists who often seek to quickly exit and bank their profits once a company goes public, Fidelity wants to stay invested in the company. "We would not expect to sell once it goes public," he said. "We would expect to buy after the IPO." In the case of Facebook, Fidelity is now its No. 1 investor, with $17.3 billion in shares.
And unlike VCs, who usually want to have a say in the strategy of a company they've given money to, Fidelity is a passive investor. "We don't take board positions," said Boyd. "We don't want to be restricted in buying once the company goes public."
One reason for the increased pace of Fidelity's investment in private companies is their long-term impact. "Private companies are disrupting to a greater extent than in the past," said Boyd. Just consider how Uber and Amazon have overturned established industries. Companies started with VC money clearly are having their impact on the economy,
A study cited by the National Venture Capital Association found that of the 1,339 U.S. public companies founded after 1974, 556 (or 42 percent) are venture-backed. The 556 companies represent 63 percent of the market capitalization of post-1974 public companies. Not surprisingly, Fidelity's biggest holdings include — in addition to Facebook — Apple, Amazon and Alphabet (Google).
Private companies are also growing larger and staying private longer. According to the NVCA, the average length of time before a start-up goes public has nearly doubled in the last two decades, from 3.5 years in 1995 to 6.6 years in 2015. With $1 trillion in equity under management (and $2 trillion in overall assets), Fidelity needs to make big investments and big profits to move the needle.
There is some risk in buying private companies. "These holdings are illiquid, so that presents some risk because they can't be sold until after an IPO," said Katie Reichart, a senior analyst with Morningstar, which tracks mutual funds. "However, private companies in total usually represent less than 5 percent of a fund's assets, and it's rare for an individual position to be even 1 percent of assets, so there's generally not a huge amount of risk given that the positions are relatively small and the rest of the portfolio is invested in liquid publicly traded stocks."
"I'm guessing the big funds represent less skeptical money than other VC firms," said Stuart Gannes, a longtime Silicon Valley entrepreneur. "They are investing by sectors already, so this represents the start-up sector allocation for their funds. Instead of doing due diligence (which is hard, anyway, because VC funds are so opaque), they are just following the leader."
The company typically pitches in $75 million to $200 million at a late stage of a start-up's life — the so-called D, E or F round — after the business model is well established and the venture is preparing for a public offering. That size investment usually means the start-up is one of those rare "unicorns," an industry term for a company with a valuation of $1 billion or more.
One example is Snapchat, which in May reported raising an F round of $1.8 billion in an SEC filing. Fidelity participated in this round for an undisclosed amount, following up on an earlier investment, reported at $175 million. The popular teen app, where messages disappear after a preset time, was recently valued at $17 billion, according to TechCrunch.
Because it is a mutual fund company, Fidelity must post the value of its investments each month — and that includes its investment in private companies. When the practice became widely known and some tech-industry darlings saw their values slashed, there was an uproar in Silicon Valley, where valuations are closely guarded. Some pundits even suggested that Fidelity could be barred from investing by secretive venture firms.
A spokesman for Fidelity discounted the complaints. "If companies balk at a little bit of public information, they're not ready to go public," he said. And some of the same companies that saw their valuations cut have since seen them restored, including Snapchat.
In fact, Fidelity sees that one of the benefits it brings as an investor is preparing private companies for the public arena. Boyd said his team will advise start-ups on the metrics that are important to buy-side managers, such as governance, stock options, M&A opportunities, classes of stock or which stock exchange to list on. Fidelity will even arrange a meeting with Fidelity's public company portfolio managers to help start-up executives get accustomed to the tough grilling public companies can endure.
"They'd like to have a little practice in being a public company," says Boyd. "It's a little bit of a dry run."
— By Joel Dreyfuss, special to CNBC.com