he initial public offering (IPO) market is undergoing fundamental changes as many IPO candidates remain private for longer periods than in the past. In this opinion piece, David Erickson looks at the reasons for this change, notably the huge new role being played by private equity. Erickson is a senior fellow in finance at Wharton and co-teaches “Strategic Equity Finance” with professor David Musto, chair of Wharton’s finance department. Prior to teaching at Wharton, Erickson worked on Wall Street for over 25 years, helping private and public companies raise equity strategically.

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Over the course of my 25-plus years on Wall Street, I worked with a lot of companies on their initial public offerings. What was consistent over this period was that the IPO market would usually ebb and flow with the broader equity market and market volatility. When the equity market was performing well and volatility was low, the IPO market was typically very active. Today, things are different. We have almost daily record highs for the S&P 500 and the Nasdaq and volatility remains at historically low levels. Surprisingly, though, IPO activity is a fraction of what it has been in recent years.

According to data from Renaissance Capital, 2017 is on track to be the second least active IPO year in the last eight, lagging just 2016 (with 105 IPOs priced). So, after several articles (including this one) called for a revival of the IPO market in 2017, activity this year remains tepid with only 62 priced so far this year.

In the Strategic Equity Finance course at Wharton, we discuss why some companies go public and others stay private. Some of the reasons for each include:

Why Some Companies Go Public:

  • Raise equity capital – in some cases, large amounts or in sectors where private financing isn’t as prevalent.
  • Have a “public” acquisition currency – while private-to-private transactions occur, agreeing on value (as there is no publicly traded price for either company) can be challenging.
  • “Monetize” shareholders – including employees and investors/backers.
  • “Branding” the company – in addition to getting visibility in the media (i.e., CEO appears on CNBC, etc.), some companies’ customers and vendors can be more comfortable dealing with public companies, given the transparency of information.

Why Some Companies Stay Private:

So, what happens if a company can remain private, but achieve many of the benefits of going public?

What Has Changed in Recent Years?

About 18 months ago, I wrote a [email protected] article about the “Unicorn” market where I argued that some successful companies were able to stay private longer because of two main catalysts. The first involved changes from the 2012 JOBS Act, which allows companies to have 2,000 shareholders (vs. the previous 500 shareholders) before having to start filing with the SEC. And second, more investment dollars were available in the private venture market.

While I had written about the increasing activity in the private venture market of prominent public market equity investors such as Blackrock, Fidelity and T. Rowe Price, I failed to note the increased buying power of private equity firms. According to Bain & Company’s Global Private Equity Report 2017, more than $2.3 trillion of “new money” has been raised by private equity firms (from buyout to venture capital to growth to mezzanine funds) in the last four years, and more than half a trillion in each of these years. The other thing to note about this new money raised is that it is unlevered equity – much of which, including most buyout and growth funds, can be levered to make investments. That is a lot of potential buying power.

“While accessing the vast pool of private capital is one path companies have pursued instead of going public, another path being rumored by prominent ‘unicorn’ Spotify is a direct listing.”

While not all of this money is focused on investing in private companies, more private equity firms in recent years have been actively investing in private companies across sectors, such as Ajax Health, Chobani, Cloudreach, SoFi, Tom’s, and Uber. Additionally, private companies have received financing to pursue strategic activities such as SilverLake increasing its investment in Dell to facilitate its recent acquisition of EMC. Previously, these private companies would likely have needed to go public to solve their financial or strategic needs.

This isn’t to say that these private companies will never go public, as their private equity backers will need to monetize at some point. However, with these alternative financing solutions, it may provide private companies with flexibility in the near-term, and if they are able and want to stay private.

In addition to an increase in investment dollars going into private companies, with the performance of the equity market since last year’s U.S. election, the strength of strategic M&A buyers has improved, and some have targeted companies preparing for an IPO. A recent example is Cisco’s January acquisition of AppDynamics the day before it was to price its IPO – at almost two times the value it was going public.

While accessing the vast pool of private capital is one path companies have pursued instead of going public, another path being rumored by prominent “unicorn” Spotify is a direct listing. In the last couple of months, several articles have noted the possibility that Spotify may avoid an IPO, and instead do a direct listing on an exchange. According to some of these articles, the rationale is that Spotify doesn’t need the money and instead wants to provide a mechanism for its shareholders to monetize.

As it is only rumored at this stage, it is unclear if the company’s reasons to go this route are to avoid the time and expenses of an IPO process (i.e., mostly, investment bank, lawyer, and accountant fees); and/or if it wants to do something unique like when Google did a “Dutch auction” for its IPO with the objective to optimize the IPO price. As when Google announced its intent to do a non-traditional IPO, Spotify’s potential path has sparked considerable interest.

“This lock-up is designed to create an orderly market for the shares as the stock ‘seasons.'”

Albert Wenger of Union Square Ventures, a prominent venture capitalist, tweeted when the Spotify articles first appeared, “Great to see, we are long overdue for some innovation in the IPO process.” However, a direct listing isn’t really a change in the IPO process (as there is no offering), but a listing of the company’s shares on an exchange. One of the biggest distinctions of a direct listing is normally all of a company’s shares are freely tradeable on day one,

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