While headlines often focus on Uber, Airbnb and other private companies valued at more than $1 billion, we are looking beyond the so-called unicorns to find opportunities for bigger returns in early-stage venture capital. In 2011, a Tel Aviv-based startup called Cyvera began developing cybersecurity software deploying the coding equivalents of barriers and traps to thwart hackers staging potentially devastating “zero-day attacks.” In October 2012, a $1 million investment was enough to buy 13% of Cyvera. Less than two years later, Palo Alto Networks purchased the company for $200 million—a more than 25-fold surge in valuation. In November 2015, Square, a San Francisco-based creator of mobile payment technology, went public at $9 per share and immediately rocketed 45% to a valuation of more than $4 billion. Great news for investors, right? Not necessarily. The prior year, Square had raised venture financing that put its value at $6 billion. Investors in that round suffered meaningful paper losses on their investment. The contrasting fortunes of Square and Cyvera underscore our belief that investors today can find more promising opportunities in early- rather than later-stage venture capital. From 2010 until 2015, the bull run in publicly traded equities led to a surge in valuations across the venture capital industry. Increasing amounts of capital were raised to take advantage of the breakneck pace of innovation. Hedge funds and mutual funds also seized on venture capital opportunities like never before. The flood of cash has centered primarily on latestage, venture-backed private companies. Indeed, in 2013, the nickname “unicorns” was coined for privately owned companies with a market value exceeding $1 billion. Today, such companies are not as rare as their name suggests: As of Feb. 23, 2016, there are 153 unicorns worldwide with an aggregate value of $537 billion compared with just eight such firms with a total value of $21 billion in 2010, according to CB Insights, a New York-based research firm. The term “private IPO” became ubiquitous last year, as entrepreneurs obtained private funding at points in their companies’ life cycles that in previous decades would have necessitated an IPO. Indeed, before the dot-com bubble burst in 2000, IPOs were considered financing rounds. In 1999-2000, companies staged an IPO at an average age of 5. Today, many entrepreneurs view IPOs as a liquidity event or an opportunity to exit—the final stage in company growth. The average age of a company executing an IPO has jumped to 11, underscoring that companies going public are much more seasoned than they were a decade ago. Amid the boom of later-stage venture capital, early-stage valuations have risen more modestly. Since 2010, later-stage financing rounds, beginning from Series D and beyond, have nearly tripled, from $64 million to $184 million. Meanwhile, valuations across seed-stage financings—the earliest entry point for private investors into venture companies—have doubled from $3 million to $6 million. Valuations across Series A rounds have grown by 150%—from $6 million to $15 million. Elevated Exits We believe that investment today in early-stage companies is more likely to meet the baseline expectation among venture capital investors for a fivefold to 10-fold gain over a five- to eight-year period. Later-stage investors face a significant challenge to achieve sufficient returns to justify taking on the level of risk: the valuations are simply too high. Venture-backed technology companies from 2010 until early 2015 exited in general at valuations from about $100 million to $200 million, according to CB Insights, highlighting our belief that investors should focus on seed and Series A investments to achieve a requisite return. Accessing the most promising opportunities in early-stage venture capital has always been a challenge. At Brown Advisory, we tap into a network that is rooted in our legacy with Alex. Brown, the lead underwriter for iconic consumer and technology companies such as AOL, Starbucks, Qualcomm, Sun, Oracle and Microsoft. We are still close to many of the investment bankers who helped finance those companies. They are dispersed across Silicon Valley and other proving grounds for entrepreneurship and give us what we hope to be a sourcing advantage. Clients can gain exposure to early-stage investments through our Private Equity Partners (PEP) vehicles. These are concentrated portfolios of high-conviction ideas, incuding venture capital. We invest in a few managers every year, leveraging our firm’s research and contacts to make long-term strategic allocations. Superior Six PEP I and PEP II are ranked in the top quartile among peer portfolios. PEP III held its final closing in 2015, focusing on six managers geared to outperform regardless of the market cycle. We recently launched PEP IV and are lining up investments with what we believe are some of the strongest venture capital managers today. The portfolio will also focus on buyout and growth equity investments, which we believe will complement venture capital on a risk/ return basis. Through the PEP model, we have invested in several earlystage standouts. We partnered with Lux Ventures, which focuses on hard sciences, nanotechnology, robotics and other areas off the beaten path of venture capital. In August 2012, Lux backed Auris Surgical, a nano-surgery company started by Fred Moll, the founder of Intuitive Surgical and creator of the da Vinci® robot. Lux invested $4.6 million in Auris at a $7.5 million pre-money valuation. In September 2015, Auris raised $150 million at a $472 million valuation, generating a 50-fold surge in the valuation in just three years. We hitched a ride on Cyvera’s ascent by partnering with Blumberg Capital, an early-stage venture capital firm investing in emerging companies in Europe and Israel. Cyvera’s beta tests backed up its marketing pitch that its software was especially potent in averting zero-day attacks, or hacking that occurs before the vendor makes any attempt to fix a software vulnerability. Palo Alto Networks snapped up the company to stay competitive in the increasingly complex field of cybersecurity. Other investors can chase unicorns. We believe there is more money to be made riding early-stage opportunities like Cyvera. Other articles in this issue: Through the Storm Stock market volatility has spiked in response to immediate market concerns about energy prices, weakening economic growth in China and changes to monetary policy, as well as momentous capital-market shifts during the past 20 years. In times like these, investors earn their stripes by staying focused on their long-term goals. By Paul Chew, CFA, Head of InvestmentsA Lift Amid Headwinds: The Appeal of Mortgage Bonds With the Federal Reserve tightening for the first time since 2006, investors may generate competitive returns from the comparatively stable market for mortgage-backed securities. By Tom Graff, CFA, Head of Fixed Income and John Henry Iucker, Fixed Income Research Analyst‘The Ultimate Mobile Device’: Redefining the Automobile For more than a century, automakers have provided a way to find adventure and new possibilities just beyond the horizon. Now the industry is also trying to satisfy consumers’ Web-focused wanderlust. By Simon Paterson, CFA, Equity Research Analyst The views expressed are those of the authors and Brown Advisory as of the date referenced and are subject to change at any time based on market or other conditions. These views are not intended to be a forecast of future events or a guarantee of future results. Past performance is not a guarantee of future performance. In addition, these views may not be relied upon as investment advice. The information provided in this material should not be considered a recommendation to buy or sell any of the securities mentioned. It should not be assumed that investments in such securities have been or will be profitable. To the extent specific securities are mentioned, they have been selected by the author on an objective basis to illustrate views expressed in the commentary and do not represent all of the securities purchased, sold or recommended for advisory clients or other clients. 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