Distinctions between public and private markets have been gradually diminishing. Historically, public markets acted as a significant source of capital and liquidity for growing companies and their shareholders; in recent years, however, liquidity has been shifting towards private capital.
Research estimates that private capital markets (comprising both private equity and private credit) are growing at twice the rate of their public counterparts. As they currently account for only an estimated 6% of the value of corporate equity and credit issuance, there is significant room for further expansion. Meanwhile, the number of public companies in the US, for example, has declined by approximately 40% over the past 20 years, and there is a clear trend globally of companies staying private for longer.
This development has manifested itself across all industries, but has been most visible across technology and the wider digital economy. As new technologies continue to disrupt all industries, investors now hold on to growth-stage tech companies for longer before exiting through listing, resulting in sizeable private companies with multibillion-dollar valuations.
There are numerous drivers attracting both companies and institutional investors to private markets. For the former, these include the prospect of greater control, less scrutiny and fewer regulatory burdens, as well as the emergence of transaction solutions and the naissance of exchanges dedicated to private capital market liquidity that allow shareholders to cash out pre-IPO. For the latter, these include private markets’ recent outperformance of public markets and the prospect of generating higher returns by gaining exposure to the high-growth phase of companies’ development.
Moreover, there is the symbiotic, self-reinforcing relationship of greater volumes of capital becoming accessible to companies prior to going public or being acquired, which serves to draw more companies to private financing solutions at lower costs of capital, in turn attracting an even wider pool of investors interested in backing private companies.
The wider pool from which private capital is drawn is reflected in the increasingly diverse profile of investors that are pursuing these transactions. Investors in any given minority private equity transaction for a growing company, be it primary or secondary, might now comprise a broad variety of alternative asset managers, mutual funds, hedge funds, wealth-management clients, corporates, sovereign wealth funds, venture & growth funds and other forms of non-traditional institutional capital. I’ve previously written on how this latter group have emerged as leading direct investors into buyout-style private-equity transactions; the same can be said of their participation in minority private capital transactions.
The dynamic of these transactions has also become far more international. Investors look globally for the best business models and management teams, and historical hurdles such as country risk premia or local legal frameworks appear less of an impediment than 10 years ago. Deal execution, however, including elements such as transaction structure, security and how to deal with uncertainty, is still influenced by cultural backgrounds.
Together, this collection of factors has strengthened and instilled confidence in the private capital markets. A key implication of this is that late-stage growth companies, while preparing to float on the stock markets, can finance growth extensively through private sources of equity and debt. Private investors have been willing to subsidize heavy losses at tech companies for the trade-off of gaining market share, with the long-term aim of achieving leadership positions.
Lastly, the route of a strategic transaction as an alternative to a listing has become more prevalent to companies that have achieved scale within the private domain. The acquisitions of iZettle by Paypal, Shazam by Apple, Souq by Amazon and Skyscanner by Ctrip are all good examples.
As well as providing capital for later-stage private businesses, private capital markets have provided a substantial stimulus to the development of exciting earlier-stage companies. They serve to fund R&D, capex and innovation at companies in emerging areas such as the Internet of Things, artificial intelligence, machine learning and 3D printing, where M&A or going public might currently be a less viable alternative.
And we should look at the opposite side of the risk spectrum as well. Infrastructure funds, traditionally well-versed in pricing real assets and companies with stable, predictable revenue streams, have in recent years started to seek exposure through minority transactions to segments of the internet infrastructure space, such as data centers.
The traction in the private capital markets has necessitated the attention and acclimatisation on the part of financial advisory services providers. Global investment banks are no longer sole intermediaries to relevant pools of capital, as they have traditionally been as effective sponsors of public listings. Instead of syndication efforts and underwriting, there is a much greater role in these private transactions for personal relationships and reputations – a true trusted advisor who combines hybrid capital-raising and M&A capabilities.
Private capital transactions have increasingly become critical in helping businesses to drive innovation, scale internationally and fund strategic ambitions, while providing financial flexibility to founders and shareholders. Although it is hard to estimate how factors such as public market volatility and geopolitical developments might impact the risk appetite of private investors , the emergence of deeper and more liquid private capital markets looks to be an irreversible trend.
