IPOs Look Dicey, But Private Equity May Pick Up Some Of The Slack
For a while, I was optimistic that 2011 would be a good year for venture capital-backed IPOs, and it wasn’t just wishful thinking. There were 72 VC-backed IPOs last year—six times as many as in 2009. The year ended with a bang and 2011 got off to a good start. In the first half of 2011, there were 36 IPOs, right on target for at least a replay of 2010.
Lately, however, I have parked my optimism at the side of the road.
Our high jobless rate has not budged, housing remains in the tank, and the sovereign debt crisis in Europe now threatens the United States. In addition, the U.S. government’s debt load grows more out of control every day. And, of course, we have stalemate over fiscal policy in Washington.
Predictably, all this makes the stock market very volatile, and that isn’t a good backdrop for IPOs. When the market goes up 200 points one day and down 200 points the next, very few investors are interested in IPOs. You need market stability and a better economic backdrop. Marque companies like Zynga, Facebook, and perhaps Groupon can probably go public in this environment (Groupon postponed plans for an IPO in September), but most companies will be on the sidelines until deep into 2012.
Many of them are good, solid middle market companies that are growing briskly and making money, but aren’t big enough, in the current climate, to interest Wall Street investment bankers. This could eventually change, but not in this market.
Fortunately, the picture isn’t completely bleak, because there are alternatives in the private market, both short-term and long-term. One is the advent and growth of markets for trading illiquid assets online, such as SharesPost and SecondMarket, which have created a marketplace for trading shares of private companies. Trading on the secondary markets allows company founders and key managers to liquidate some of their stock and tie themselves over financially until their real payday comes along.
Longer-term, more private equity buyers may enter the fold to help middle-market companies monetize themselves. The incentive is there; unlike the IPO market, a record amount of cash was generated from exits in the private equity sector in the second quarter, inspiring confidence in the asset class. According to Preqin, an alternative asset research firm, private equity general partners generated $120 billion from 300 exits in the second quarter.
Seasoned technology private equity firms such as TA Associates and Summit Partners are already a part of this picture as so-called growth capital investors, and they focus heavily on middle-market companies—companies with revenues of $50 million to $1billion that are typically profitable. In aggregate, these middle-market companies generate more than $6 trillion in annual revenue, or 40 percent of the national GDP, and employ 25 million people.
TA Associates, Summit Partners, and other companies like them usually make a minority investment in such companies when they are seeking help to finance a transformational event in their lifecycle, such as a substantial international expansion. In addition to their capital, these firms provide strategic guidance and a significant network of contacts. Unlike venture firms, they often use debt rather than equity in their financings.
Corporate recipients of growth capital don’t necessarily want money for international expansion. They may want money to diversify their product line, for example, or to expand into a related but new field. But in a global economy, particularly at a time when the U.S. is growing much more slowly than it once did, accelerated international expansion is often the highest priority. International business surveys show that well over half of executives of midsize American businesses plan to increase their overseas sales targets.
Many growth capital companies eventually go public, but with a substantial lag. Some middle market companies may seek more aggressive avenues for growth—they can be acquired, operated and re-tooled to become more successful , for example. This is traditional work for a private equity firm in select industries. Such scenarios, however, are far less likely in the case of technology companies.
It would be easier and probably better if seasoned and strong technology companies could go public today. But if they cannot, it’s nice to know that there may be options besides acquisitions.