Finding Value in the Private Markets
The article below is from our BRIEFINGS newsletter of 24 June 2019
In a trend that has reshaped the financial landscape, private markets continue to gain traction as a popular alternative for companies to raise money. Mike Voris and Lyle Schwartz, who lead Goldman Sachs’ equity private placements business globally, recently shared their views on the drivers and implications for both companies and investors.
What’s fueling the growth in private fundraising?
Mike Voris: In the last few years, a massive amount of capital has flowed into the private market – particularly for mid-to-late stage companies that historically would have relied on an initial public offering to fuel growth. This increase in capital has allowed companies to stay private longer without the burdens of going public and it has also helped contribute to meaningful value creation. A recent McKinsey report estimated that between $250 billion to $300 billion was invested in private companies in 2018, with 25 companies raising over $1 billion.
Lyle Schwartz: Investors are increasingly comfortable with -- and excited about -- investing in companies earlier in their lifecycles. And companies get access to a broad and diversified investor base that can include corporates, hedge funds, mutual funds, family offices, private equity and venture capital funds, as well as sovereign wealth funds. As a result, these early stage companies are generally no longer beholden to any one investor type that will determine the direction of the company.
What are the most common ways that investors access the private markets? How is that growth affecting market structure?
MV: Private placements make up the vast majority of private market transactions, although there are some emerging areas such as initial coin offerings and crowdfunding that receive press coverage. Basically, a private placement is the sale of an unregistered security – typically an equity or equity-related instrument – in a company that’s not yet publically traded. We’ve seen a material increase in recent private placement activity. In fact, in the first five months of this year, we’ve led nine deals, raising $3.5 billion in growth capital, and our year-to-date volume has already surpassed last year’s levels.
More broadly, the dynamic between the public and private markets has shifted such that more of the valuation gains are happening in the private markets. Our colleagues in Goldman Sachs Research have estimated that on an absolute basis, annualized private market gains for companies going public over the last five years was 30+% higher when compared to the last 25 years. In fact, we’ve seen cases where companies have been able to raise several mega-rounds with significant valuation step-ups to take advantage of this strong market. This, in turn, is leading to a “super cycle” of IPOs, especially in the tech sector, where companies going public are significantly larger than in the past.
LS: Global activity is accelerating, as private market fundraising has become increasingly diversified – both across industry sectors and geographically. Europe now has over 60 unicorns measured at the end of 2018 more than seven times the number just five years ago, primarily in the technology, software, fintech, mobility and healthcare sectors. Investors are also engaging in cross-border transactions with non-US investors interested in private placements in US companies and vice versa.
With companies staying private for longer, how does that affect investors’ ability to get their cash back?
LS: It’s true that investors are taking a “liquidity discount” by tying up their money for a set period in exchange for access to potentially high-growth opportunities. And as more investors allocate money to private investments over public ones, that’s bound to have an impact on overall market liquidity. But from an investors’ perspective, private market investments can help diversify their portfolios because they are largely non-correlated to the public markets. At the end of last year, for example, when the markets were selling off, people in private investments experienced far less realized volatility.
MV: The structural changes in the private markets are also creating a boom in secondary transactions for pre-IPO liquidity – especially for VC firms that have been invested in a company for 7+ years, but also for founders and employees who want to access liquidity earlier. In the last 12 months, for example, we’ve led secondary transactions for Credit Karma, TransferWise and Workfront.