Research suggests there's no stopping the private-equity train
According to new research published by a global group of institutional asset owners and service providers, the PE industry has grown more than 500% since 2000 to exceed US$3 trillion in value. That acceleration has come thanks to significant demand from investors as well as changing dynamics that affect how companies raise capital.
“Today’s knowledge-based business models tend to be asset light, and having a significant proportion of investment in intangible assets acts as a drag on earnings,” explained Liang Yin, senior investment consultant at the Thinking Ahead Group.
The report noted that such businesses are increasingly able to outsource manufacturing, large-scale computing, and back-office functions. Because of that, start-up businesses tend to be more vulnerable to imitators and competitors, especially when they comply with the disclosure requirements that come with entering the public market.
The fact that intangible assets are regarded as an expense based on contemporary accounting standards also weighs on the earnings of companies that rely heavily on such assets, making them appear less attractive to investors. Businesses that go public must pay a substantial cost for an IPO — around 5% in the US — followed by the need to demonstrate good performance every quarter, as opposed to a five- to seven-year cycle for general partners.
Yin added rising regulatory pressure and rising ongoing costs of being a listed company to the drawbacks that make businesses more inclined to remain in the private markets, where there is abundant capital available.
“[W]e have seen a significant decline in the rate of public listing,” the report said. “In the US, between 1980 and 2000, an average of 310 operating companies listed per year; this number dropped to 99 per year between 2001 and 2011.” The number of listed firms in the US stock market, it added, has declined from more than 8,000 in the late ‘90s to just above 4,000 today.
Corporations that decide to go public are also now more likely to do so in the later stages of their existence, by which point they’ll have realized a significant chunk of their growth potential. That’s a critical consideration for investors, particularly those who want significant returns from their portfolios.
The report outlined four major options for investors to access PE:
- Counting on companies in an existing public-equity portfolio to acquire young and growing private companies;
- Investing in private equity/venture capital funds;
- Co-investments, with a private equity fund as general partner and investors as limited partners; and
- Investing directly in private equity without going through specialised PE funds.
“Companies are no longer using public markets in the same way to raise capital,” Yin noted. “The decision to list is increasingly driven by the desire to cash out, and that normally happens when businesses reach a scale so large that only the public market provides enough liquidity to allow many of the early investors to cash out at the same time.”