Private capital markets surge helped by blessing of unicorns
The growing use of the capital markets by private companies – and the growing size of those companies – is proving a boon to investment banks, with bankers increasingly reliant on fees generated by the huge rise in the number of so-called "unicorns".
Privately held companies have grown in sophistication as well as size and there has been a major shift in their use of capital markets, bankers said. That, in turn, has made secondary markets for private investments more liquid and attractive for investors, producing a virtuous circle that attracts more investors and encourages more such companies to raise funds.
Assets managed in private markets strategies have more than doubled in the past decade to more than US$7trn, according to analysis by Goldman Sachs.
Leading the way are unicorns, or private firms that are valued at US$1bn or more. There were 392 unicorns as of September – a "blessing" of unicorns to use the collective noun – compared to just nine a decade ago, according to the Goldman report. In the first half of 2021 alone, 155 firms attained unicorn status.
They need financing to fuel their rapid growth, and all the major banks want some of that business. Firms including Bank of America, JP Morgan, Goldman, Citigroup and UBS have long been active in private placements, but ramped up their focus on private capital markets several years ago and many created dedicated teams within or alongside equity capital markets groups. They continue to evolve structures and hire staff to try to gain an edge.
“This year has been a real breakout year in terms of the quality and the size of the business we’ve been able to raise private capital for,” said Gareth McCartney, global co-head of ECM at UBS. He said a theme of the year had been the emergence of “a true liquid private placement market” in Europe.
The traditional route for private companies – initial public offerings or M&A deals – has been added to by the option of special purpose acquisition transactions after a boom in SPACs in the last two years. “It gives them an extra item on the menu,” McCartney said.
Several bankers said the shift appeared structural, rather than cyclical, and showed the line between public and private markets was increasingly blurred.
“The investment banks and the buyside are all taking this as a long-term trend; this is not a short-term phenomenon at all. The statistics are too clear, too large and all trending in one direction for it not to be,” said James Palmer, head of ECM for EMEA at Bank of America.
Another senior banker said the surge of SPAC deals – and in particular the use of PIPEs, or private investments in public equity, inherent in SPACs – has built up expertise and acceptance of private placements and enlarged the ecosystem around private companies. Private placements have also filtered down to mid-sized companies as banks catch them earlier in their lifecycle than ever before.
Private for longer?
The Goldman analysts said it was “conventional wisdom” that companies were staying private for longer before becoming public companies. But they said that the change was marginal: the average time from founding to IPO is now about 10 years, compared to nine years in 2006.
Crucially, companies are raising far more capital in private markets before they do an IPO, and each round is often lifting their valuations. In 2006 the average amount raised pre-IPO was US$43m; that is now US$222m.
“There’s been a pretty significant shift in the capital formation process for companies,” said Kristin Kramer, head of US capital introduction at Goldman, on a recent podcast on the topic. “What has changed is the enormous amount of value creation during the private phase of a company’s life.”
Wide range
A wide range of investors now back private companies with sizeable investments – venture capital firms, private equity shops, hedge funds, other institutional investors, plus wealthy individuals and family offices.
They are attracted by good returns (potentially uncorrelated with the rest of the market and their other holdings); high growth prospects; potential synergies with other private or public companies in their portfolios; the possibility to get in early ahead of IPOs; and because such investments can help dampen volatility in portfolios where public assets have to be marked to market daily.
Another appeal for traditional asset managers is an ability to be an active manager at a time of a shift to passive investing.
“This area doesn’t have any passive product so if you want to justify your active investing the private arena is the perfect place to do it. That’s a big long-term dynamic for the buyside’s interest,” said BofA’s Palmer.
Bankers said this backdrop means unicorns can get access to as diverse and high-quality capital sources as public firms do.
Hedge funds are among those stepping up their involvement in private markets. They participated in 770 private market deals in the first half of 2021, with an aggregate value of US$153bn, the Goldman report estimated. That already topped the record level of 753 deals worth US$96bn set in 2020, and compared to an average of just over 50 private deals a year in the decade to 2010 and about 200 deals a year between 2010 and 2015. Hedge funds typically participate in the larger deals, and accounted for about 27% of the capital deployed in private companies so far this year, Goldman said.
In such an environment, it is no surprise advisory boutiques and bulge bracket banks are ramping up coverage of private firms. Bankers said it had been a challenge attracting experienced specialists to do that work, with ECM bankers increasingly tasked with originating and executing private transactions just as they do with traditional IPOs.
Investors are also increasing staffing to take advantage of the opportunities. Hedge funds, for example, have increased headcount not only in their private capital investment teams, but some have also hired people with experience of private companies to their accounting, marketing and legal teams, the Goldman report said.