Not long ago, when a privately owned company with a market value over $600 million needed capital to expand their operations, the only option was to pursue an initial public offering (IPO) and become a public company, listed on a stock exchange.
Today, companies are choosing to stay private longer. An IPO is no longer the dream outcome of many of today’s entrepreneurs and vast pools of private capital are allowing some of the world’s best companies to achieve incredible scale while remaining private. Entrepreneurs and management teams like the efficiency of private markets and prefer to avoid the transaction costs associated with public listing. This has changed the investment landscape dramatically and means private equity has become a consideration for investors who want access to the full spectrum of the best companies.
Private equity keeps growing in importance
Although public share markets have continued to grow over the last two decades, the pace of growth in private equity markets has far exceeded this.
And the number of publicly listed companies in the US has declined by nearly 50% in the last twenty years, from over 7,000 companies in 1996 to below 3,800 by 2016.1
Why the decline in public listings? First, private transactions have some built-in advantages. Relative to IPOs, private equity offers price certainty, faster execution, more upfront liquidity, and active ownership. Second, staying private has been made even more attractive as regulatory changes have resulted in increased compliance and costs for public companies.
Returns from private equity have been strong, highlighting the high quality of the companies choosing to stay private. According to PwC, private equity has been the best performing global asset class on a five, ten and 20‑year basis.2
Who is providing all the private capital?
Markets have become global and the scale of private capital providers today is staggering. The types of investors providing private capital has significantly expanded, to include investors like global advisory firm SoftBank’s nearly $100 billion ‘Vision Fund’, sovereign wealth funds and large ‘family offices’ (private firms that manage investments for a single high net wealth family). Private equity firms are also willing to invest in a broader range of transactions than previously.
In addition, cash-rich corporations are setting aside large pools of capital for private company acquisitions as they look to gain new sources of earnings and take advantage of emerging market trends.
And increasingly, super funds are including non-traditional assets like private equity in their portfolios.
Regulatory change has helped private companies
In the last few decades, regulation has reduced the incentives to go public, while loosening regulation in the private markets means there are greater benefits to staying private.
One piece of US legislation that is often cited as increasing the compliance costs for public companies is the 2002 Sarbanes-Oxley Act (SOX). A response to scandals like Enron and WorldCom, SOX outlined stricter reporting and accounting requirements for public companies.
In 2011, EY estimated3 that a new US listed public company can expect to spend, on average, an additional $2.5 million annually post-IPO, with costs relating to management salary increases, compliance, recurring advisory fees, new technology and expansion of the board of directors.
In Australia, a listed company is required to inform the market about price sensitive information, but these continuous disclosure provisions no longer apply when the company is taken private.
On the other hand, private markets have benefited from loosening regulation that has enabled private companies to attract new sources of capital and stay private longer. A key US legislative change was the 2012 Jumpstart Our Business Startups Act, which raised the cap on the number of shareholders in a private company from 500 to 2,000. Both Google and Facebook undertook IPOs when they reached the 500 investor limit. In Australia, 2016 legislation included tax incentives for investors in early stage private companies.
The regulatory changes have contributed to an increase in the pool of private companies, as well as the trend of these companies staying private until they are at a much more mature stage. For example, in 2006 the average private equity investment was held only three years before IPO, but by 2015, this had increased to seven years.4 Among technology companies, the average age of a company before it went public increased even more dramatically, from four years in 1999 to 11 years by 2014.5
The other benefits of staying private
Staying away from the public markets also allows entrepreneurs to take a long-term view and ride out market cycles without the same concern for negative press. They can also keep growing rapidly without focusing on short-term profitability or having to provide detailed information about their strategy to the public markets.
The typical profile of today’s emerging companies is also often well suited to the private markets. With digital transformation and low-cost cloud-based services, start-up companies often need less capital than they did in the old industrial economy. These asset-light models scale well, reducing the need to seek public funding. Private markets are also suited to evolving business models - these might deter traditional IPO investors, who expect a company to have a stable business model.
Less pressure to move to an IPO
In the past, liquidity of a company’s shares was seen as the key to attracting talented employees to companies and an IPO was often a company’s first liquidity event. This meant it was important for companies to go public early to attract and retain talent.
Now private liquidity programs, which allow shares to be purchased from employees and other eligible shareholders, are increasingly commonplace. Secondary liquidity is a structured and sophisticated market, where companies often accept private capital through a combination of new primary capital and secondary capital from existing shareholders selling some of their stakes. Founder and employee liquidity is no longer seen as taboo and there are now exchanges that allow investors in private companies to trade their shares.
Investors have emerged who have longer time horizons and don’t need early liquidity events. They are comfortable holding quality companies over the long term if their capital is compounding at attractive rates. Some private companies switch hands between private sources of capital, never reaching the public markets.
Like many global counterparts, the Australian government has helped develop crowd-sourced equity funding to expand financing options for private businesses, enabling fund-raising from a large number of small investors.
Are you already a private equity investor, without realising it?
If you invest your superannuation in MLC’s diversified multi-asset portfolios, you may already have a holding in private equity. For example, MLC Horizon 7 - Accelerated Growth currently holds 10.7% in private equity, and MLC Inflation Plus - Conservative has a 2.7% holding.6
This information is provided by NULIS Nominees (Australia) Limited (ABN 80 008 515 633, AFSL 236465) trustee of the MLC Super Fund (ABN 70 732 426 024), issuer of the MLC MasterKey Super & Pension Fundamentals, and a member of the National Australia Bank Limited (ABN 12 004 044 937, AFSL 230686) (“NAB”) group of companies (“NAB Group”). An investment in any financial product referred to in this communication is not a deposit with or liability of, and is not guaranteed by NAB or any of its subsidiaries.
This information may constitute general advice. It has been prepared without taking account of an investor’s objectives, financial situation or needs and because of that an investor should, before acting on the advice, consider the appropriateness of the advice having regard to their personal objectives, financial situation and needs.
You should obtain a Product Disclosure Statement relating to the MLC MasterKey Super & Pension Fundamentals (PDS) , and consider it before making any decision about whether to acquire or continue to hold any interest in the product. A copy of the PDS is available via mlc.com.au or you can call 132 652 and request a copy.
Past performance is not a reliable indicator of future performance. The value of an investment may rise or fall with the changes in the market. Opinions constitute our judgment at the time of issue and are subject to change. We believe that the information contained in this article is correct and that any estimates, opinions, conclusions or recommendations are reasonably held or made at the time of compilation.
This information is directed to and prepared for Australian residents only.
1 Center for Research in Security Prices (CRSP).
2 PwC, The rising attractiveness of alternative asset classes for Sovereign Wealth Funds, January 2018. Past performance is not indicative of future performance.
3 Ernst & Young LLP, True Costs of IPOs survey, 2011.
4 PitchBook Data.
5 McKinsey & Company, Grow Fast Or Die Slow: Why Unicorns Are Staying Private, 13 February 2017.
6 NAB Asset Management Services Limited. Based on the MLC MasterKey Super Fundamentals MLC Horizon 7 - Accelerated Growth Portfolio and the MLC MasterKey Super Fundamentals MLC Inflation Plus - Conservative Portfolio at 31 October 2018.