When private equity firms buy a company they don’t want to hold onto it forever, and one of the standard exit strategies is to take it public (not always for the first time) with an IPO. But there just wasn’t enough appetite for new offerings among investors after the financial crisis and the pace of IPOs collapsed, leaving a long queue now that the market has improved.
“March proceeds are up 143% against last year and volumes are up 46% against last year, so it’s moved into the first quarter here clearly, as well. Markets, as you know, like stocks to be rising for IPO market health, and also, they like low volatility,” said Michael Rogers, EY’s global deputy private equity leader in a recent [email protected] podcast, leaving a “There’s a lot of company in the queue for exit, and the IPO markets are holding up very strongly.”
PE funds staying involved after the IPO more often
Critics have pointed out that the rate of money-losing IPOs is only slightly behind the tech bubble 90s, but there’s no denying that investors are happily putting their money down. The difficulty of finding strong returns and the common feeling that the economy is going to come roaring back any time now have given private equity firms an IPO window that Rogers expects to last at least through the end of this year.
But the IPOs are taking a different form than they have in the past, with PE and venture capital funds actually participate in the IPO, staying involved with the company for a longer timeframe than they would have in the past.
“This is somewhat unprecedented, and it’s adding a lot of strength to the offerings and a lot of confidence for the public buyers and even institutional buyers to know that the investors are still in for the long haul,” said Stephen M. Sammut, a senior fellow and lecturer at Wharton, during the podcast.
Sammut still expects them to fully exit in the long-run, but selling opportunistically over a couple of years gives investors more faith that they are buying a solid company than seeing the former owners exit as quickly and cleanly as possible.
LPs selectivity is driving PE consolidation
Alongside improving conditions for IPOs private equity funds have had a strong year for fundraising, driving consolidation in the industry. Part of the inflows are because institutional investors are realizing that they need more fundamental diversification to guard against another downturn, but rising equity prices also play a role. A pension fund with a target 10% investment in PE, for instance, would have had to withdraw when the stock market crashed. Now that the market is back up they have to reinvest to stay in line with those same targets. But Sammut and Rogers agree that there is more money going to a smaller number of PE funds.
“LPs are making selective decisions and putting more capital with the bigger funds, and so we’re seeing a transition in the industry,” says Rogers. “[Smaller or middle market funds] are opting not to go forward… they’ve decided and publicly announced, ‘We’re not raising another fund’.”
By putting more money with a few large funds, LPs are able to negotiate fee discounts, direct investment rights, and other benefits. But this also means that large cap opportunities are even more important as PE funds look for ways to put all that cash to use. The increased competition for large cap acquisitions could end up pushing their prices higher, damaging PE returns down the road.