Shifts in Value Creation: The Rise of the Private Markets

Would it surprise you to know that many of the largest investable market in the United States is not the public stock market, and that this market creates more value for investors than the public market? While the internet revolutionized the trading of public stocks in the 1990s, it has barely made a dent in the trading of private securities, until now. And during that time, there’s been a profound paradigm shift between the public and private markets, and it’s changing how and where value creation occurs for shareholders.

The infamous IPO.

In the late 1990’s and early 2000’s, startup companies often sought to do an IPO as soon as possible. The process of moving from seed capital to venture capital to private equity to IPO could take place relatively quickly. It took Amazon only three years (1994-1997) to go from a startup to a public company, and at public offering it was valued at $438 million.

Many of us have heard about investors generating sizable returns from participating in Initial Public Offerings (IPOs). For instance, if you invested in the Cisco IPO, you would have made 846 times your investment at today’s price. Additionally, Amazon shareholders have received over 2000 times their initial investment since its IPO in 1997. A large portion of an asset’s growth had been realized during and following a company’s IPO.

The Big Shift

According to Preqin’s Future of Alternative Assets Report of October 2018, “In 1996 the median amount raised prior to IPO in the US was just $12 million, But in 2016, that had shot up to nearly $100 million, easily within the range of a public company’s traditional valuation.” Private companies are finding access to capital that allows them to grow. Remaining private enables companies to retain greater control and focus and fewer reporting requirements. This new trend means that private investors have the opportunity to capture more of the lucrative early-stage enterprise growth, which is making way for the proliferation of the so-called “unicorns”.

Today, companies are choosing to go public at a new stage in their lifecycle and private equity firms are holding their investments longer. They are striving to capture more years of rapid growth and create more value for private investors. Airbnb was held as a private company for 12 years and was valued at $86.5 billion when it went public in 2020. Ultimately, investors follow opportunity and have taken note of the new value creation paradigm by increasing their alternative asset class allocations.

According to a recent study by Bain & Co, private capital markets have grown in recent years. In 2020, private markets raised over $1 trillion. In a recent report by accounting giant PWC titled Prime Time for Private Markets, private equity is expected to grow by $2.1 trillion between now and 2025. With more capital flowing into the private markets, it is not projected that there will be a return to quick IPOs anytime soon. This trend is reinforced as more capital is raised and more investors gain access to alternative assets and private market investing.

Additionally, there is an increase in the number of private companies in existence today versus a few years ago. In Prime Time for Private Markets, PWC shows the number of private companies in the U.S. with 500 or more employees nearly doubled from 12,824 in 1998 to 20,139 in 2017, resulting in a 52% drop in publicly listed companies during that same period. And that trend continues in more recent years.

Value Creation for the Private Markets

As private equity and venture capital firms continue to hold and develop their portfolio companies longer, they generate greater returns. The data below illustrates the value creation shift taking place.

In the case of Netflix, only a fraction of the total value created went to the private market. At the time of its IPO, private investors just about doubled what they invested. By contrast, Facebook private investors held their stake and saw their investment valued at 34 times the average price paid at its IPO.

Unlocking Private Market Access Using the Blockchain

The implications of increased value creation in the private market are profound, especially when combined with the promise of blockchain technology. The blockchain has created opportunities for existing private investors, as well as deal sponsors like private equity and venture capital firms.

As the size of the private market expands, the need for liquidity increases. This need can be addressed with tokenized private capital units which are freely traded; and firms that specialize in developing infrastructure and networks for tokenized securities, like Securitize, have enabled this asset tokenization. Similarly, private equity firms will benefit from the potential of increased liquidity in the secondary markets and opportunities for tokenized primary offerings, and retail investors who were previously locked out of participating in alternative asset investments are on the verge of access to an enormous market.

The Bottom Line

Companies are remaining private longer for a few key reasons. Mainly, they are eager to take advantage of operating freedoms that are otherwise burdensome in the public markets. Pair that with the readily available capital in the private markets, and you have a scenario where companies are striving to grow in the private markets for years before even considering an IPO. For investors, this means that high growth potential IPOs like Amazon and Cisco are yesterday’s news. Investors are increasingly looking to private markets for these high growth potential opportunities that the public markets used to dominate.

Contributing Writers: Michael Penfield, Christie Olsen