By Steven Tredget, Partner at Oakley Capital
The universe of public companies is shrinking. Data shows that the number of listed stocks across Europe, the UK and US has fallen around 20% over the last decade. More companies are remaining private, avoiding the stock market and finding other ways to fund their growth. Often, they are high-growth business in the most attractive sectors such as tech. This trend will have profound implications for equity investors, shutting them out of the best opportunities. So why are companies avoiding public ownership, and what can investors do about this? Private equity is part of the answer, and the solution.
IPOs are expensive
Floating a company takes a lot of time and money. You have to pay fees for underwriting, accounting, legal, advisory and public relations. Companies have to prepare a very detailed and long prospectus, which provides all the material investors need to know in order to make an investment decision. On top of legal and accounting fees, you have to pay fees for underwriting and public relations. All this preparation can take many months to complete, eating into management time distracting from the day-to-day job of running the business.
Life as a public company can be a burden
Assuming the IPO is a success, and this very much depends on the state of the economy and capital markets, the additional demands on resources and time continue into public listed life. Companies will have to produce detailed financial statements and reporting documents on a regular basis. They will need to maintain a corporate head office, build a board to provide strategic oversight, and maintain investor relations to address the competing interests of an extensive shareholder base. These costs will likely grow as new regulations increase reporting requirements for PLCs. CEOs may also bristle at the idea of having to share valuable, confidential information about the business with their competitors!
The tyranny of the financial calendar can encourage short-term decision making and short investment horizons as investors focus on quarterly earnings. This was a key issue raised in the Kay Review almost ten years ago, which looked at ‘short-termism’ in equity markets and how this impacted long-term profitability and the wider UK economy. Separate, but equally important, has been the introduction of new regulation such as MiFID II, which has had the unintended consequence of reducing equity research coverage and distribution, particularly for smaller companies. This can make it harder for investors to understand a company’s performance, impacting its valuation as it struggles to attract buyers of its shares.
Perhaps the biggest driver in the decline in public companies has been the emergence of new sources of capital. While founders previously may have had to put up with the burdens of being a PLC, today they can tap the debt markets for low-cost finance, find investors on crowdfunding sites, or partner with private capital providers. Indeed, just as the universe of listed stocks has shrunk, the pool of private businesses backed by private equity (‘PE’) has surged. Pension funds and other institutional investors on the hunt for strong returns have poured money into private equity, providing PE with ample capital to invest in private businesses.
The attractions of private equity
Private equity investors tend to have a longer-term horizon that can support investment that underpins long-term performance. A recent report by Reuters found that shareholders typically remain invested in a quoted stock for just five months. The average investment period for private equity is three to five years. In addition to accessing capital, CEOs may choose private equity over the public markets for the growth expertise they can lend during their period of ownership, particularly after a crisis such as a global pandemic. They may choose to partner with a PE firm that can help them expand overseas, map out an M&A strategy, or move their business online, without having to worry about updating the public markets every four months.
What this means for private investors?
In the past, private equity was an industry and an asset class that only the very richest investors could access. That is changing as PE democratizes. Platforms such as Moonfare allow private investors to back the most promising private equity funds. Some PE firms have themselves floated, allowing investors to buy their shares. There are also listed private equity trusts, which provide liquid access to underlying portfolios of high-growth, private businesses. The bottom line is that many companies are choosing to remain private, particularly in high-performing sectors such as technology. Investors who want to tap into these growth opportunities should consider private equity as an attractive way in.
Steven Tredget is a Partner at Oakley Capital, the investment adviser to listed private equity trust Oakley Capital Investments Limited.