IPO alternatives emerge as massive asset pile burdens private equity

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As the market for initial public offerings bounces back after two lifeless years, investors who’ve been impatiently waiting for their payoff are finally getting some returns.

But the revival hasn’t come fast enough. Behind the scenes, the private-equity shops saddled with bulging portfolios — and the banks and exchanges that make millions helping companies go public — are still scrambling to come up with alternative exit strategies.

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Some are turning to private sales of shares, while others are establishing new semi-public exchanges to tempt companies to market. Inside at least one buyout firm, executives want to rejig long-accepted investment frameworks to address the new reality.

The reasons: A return to true health in the IPO pipeline could take until next year, and a record US$3.2 trillion was tied up in aging, closely held companies at the end of 2023, according to Preqin Ltd. data. That’s a problem for private equity, which relies on the cycle of raising money to make acquisitions, exiting via a sale or IPO and then returning money to investors, before ultimately asking for more funds to do it all again.

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At the same time, startups are staying private for longer, stranding everyone from employees holding small stakes to investment firms with billions of dollars tied up.

All of them are trying to answer the same question: Is there really an alternative to the time-worn path of taking a company public?

“We’re seeing evolutionary forces at work now after a couple of really tough years,” said Kelly Rodriques, chief executive officer of Forge Global Inc., a market infrastructure and data provider that runs a private trading venue. “There will always be a place for a public market exit, but the systems that are being built enable them to have a private life that’s as long as they want.”

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While the IPO market has shown signs of life in recent weeks, volumes are still at a decade low, and the rebound will only continue if notoriously jumpy issuers aren’t derailed. It doesn’t take much more than a rocky few days for stocks — or a messy presidential election — for companies to postpone or cancel debuts.

Staying private can also appeal to companies that want to avoid the regulatory scrutiny and frequent investor updates that come with a public listing. If they want to keep the IPO option on the table, they can wait for the perfect moment, refine their pitches and lay the groundwork for a blockbuster debut.

For example, Reddit Inc. waited nearly two decades and raised about US$1.4 billion before finally going public this year, according to data provider PitchBook. Shares are up about 50 per cent. Twenty years ago, Alphabet Inc.’s Google had received just US$25 million in private funding in the six years from its founding to its 2004 IPO.

Those dynamics — combined with a boom of leveraged buyouts during the era of ultra-low interest rates — mean the number of public companies in the United States has almost halved since it peaked at around 7,500 in late 1997, according to the Center for Research in Security Prices.

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New backers

Traditional institutional investors haven’t sat on their hands while the next generation of high-growth companies has been gestating in private. Firms such as T. Rowe Price Group Inc., BlackRock Inc., Fidelity Investments and others have piled into mid- to late-stage funding rounds. And private equity firms like Bain Capital LP and TPG Inc. have established venture businesses to do the same.

“The spectrum of investor capital for private companies has matured to a point where we see nearly the same types of active institutional investors in both the private and public markets,” Karin Fronczke, head of global private equity investments at Fidelity, said. “It is no longer just the VC investors on Sand Hill Road financing these businesses.”

Even with a wider pool of private backers, at some point, investors need to realize their gains.

EQT AB is the most vocal of the private-equity giants looking to break the mold. Chief executive Christian Sinding said EQT would rather hold onto some of the top-performing companies in its portfolio.

“With the volatility and other concerns that you see around the IPO market, we do feel the need to develop alternatives,” he said.

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The firm is developing permanent capital structures that would allow it to keep companies beyond the typical five- to seven-year holding period.

In this model, it would be able to keep some of its best assets in-house while selling or taking others public, creating much-needed liquidity for the companies it wants to hold onto.

Investors will need to be convinced.

“LPs don’t want to be solving problems for GPs,” Sascha Pfeiffer, head of the European technology group at Houlihan Lokey Inc., said at the firm’s recent tech conference in London, referring to the big investors such as pension funds and insurance companies that typically put money into private-equity funds.

“You can’t go to them and say, ‘We can’t get the right multiple for this investment in the market right now.’ But if you say to them, ‘We have genuine conviction behind this business and want to keep it,’ then it makes sense.”

Stake sales

Private-equity firms can also free up cash by offloading a stake in a company to peers and their own investors. Norwegian software company Visma AS, which is backed by private-equity firm Hg Capital LLP, last year brought in about 20 new investors including Jane Street Group LLC and New York City Employees’ Retirement System in a share sale that valued it at 19 billion euros.

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“This option does not provide a full exit, but it does provide an attractive route to partial monetization,” Athena Theodorou, managing director for EMEA technology investment banking at UBS Group AG, said.

If traditional IPO venues can’t beat those trying to pitch the virtues of staying private, some figure they may as well join them. In the United Kingdom, where the amount raised via IPOs last year was the lowest since the financial crisis, the government is developing a structure that would allow private companies to dip in and out of a public listing.

PISCES — an acronym for the U.K.’s proposed Private Intermittent Securities and Capital Exchange System — is a regulated market that would give unlisted companies opportunities to go public for a short period of time, for example, three days, with limited disclosures.

A valuation would be decided in a similar way to a traditional IPO: the seller can set a price after consulting with potential investors, and then an auction will take place on the platform to determine where the stock would trade.

“The idea is that it is a private market with a few public market aspects, rather than the other way round,” said Mark Austin, a partner at law firm Latham & Watkins who’s been working on Pisces.

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Charm offensive

The London Stock Exchange Group (LSEG) would run one of the first PISCES venues and has been on a charm offensive in the U.K. capital, marketing the platform to large law firms and investment banks, people familiar with the matter said. PISCES will also be open to other bourses.

It might be hard for them to get banks on board. The structure means listings could be limited to small companies and employees trading personal stakes in larger private firms, rather than the syndicated transactions that generate big fees for bankers, some of the people said.

“We have a growing cohort of companies that want to use our new venue,” Darko Hajdukovic, LSEG’s head of new and private markets, said. “We have had positive feedback from advisers and investors.”

Still, while the potential pool of individuals who could invest in private assets such as pre-IPO stakes remains small, Wall Street is lining up to cater to them. Buyout firms are increasingly courting individuals; they hold around US$4 trillion in alternative assets under management, and the industry wants to increase that figure to $12 trillion in the next 10 years, according to a Bain & Co. report.

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Investor protections

New products are also being envisioned to tap the interest. In April, Forge launched an index fund tracking 60 late-stage venture-backed companies, including Space Exploration Technologies Corp. (SpaceX) and Databricks Inc. Destiny Tech100 Inc., a similar fund that invests in tech startups such as Stripe Inc., SpaceX and OpenAI Inc., has had wild swings since it started trading in March; it briefly topped a US$1-billion valuation, compared to its most recently disclosed net asset value of US$54.3 million.

Investors have piled in, but some observers are concerned that such vehicles could dilute the protection that regulated public markets have traditionally offered.

It’s essential to preserve the integrity of fully transparent trading and the role of true public offerings, said Richard Metcalfe, head of regulatory affairs at the World Federation of Exchanges, a trade association for stock exchanges.

“Public confidence in markets is a precious commodity in its own right,” he said.

Bloomberg.com

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