2020-04-01_Business_Traveller_UserUpload.Net

52

APRIL 2020 businesstraveller.com

OPINION

BENJAMIN

SOUTHAN

JOHN STEPEK

EXECUTIVEEDITOROFMONEYWEEKMAGAZINE

P

ublicownershipis so1990s.

Therealmoneythesedaysis

madebeforecompaniesgo

publiconthestockmarket.By

raisingfundsinprivatemarkets,

firms can grow,freefromthepressuresof

quarterly reporting,regulation,tight

scrutiny anddemandingretailshareholders.

In the US,thenumberoflisted

companieshasalmosthalvedsincepeaking

in 1996. It’sa trendthatacceleratedafterthe

2008 creditcrunchsawinterestrates

collapse, makingdebtfundingmore

attractive andeasiertoraise

for entrepreneurs.

This is akeydrivingforce

behind theboominthe

valuations ofprivately

backed companies.Therise

of start-upsbackedby

venture capitalists(VCs)

and privateequityfirmshas

gifted us theterm“unicorn”

• an unlisted company valuedatmorethan
  US$1 billion.
  The idea is that investors get
  in early on the most exciting
  companies, which are usually
  technolog y-related, and the
  funds are used to grow the
  start-ups. Then backers “exit”


• selling either to another private backer or
  by listing the company on the stock market
  (via an IPO – initial public offering ),
  multiplying their initial investment.
  At a time when interest rates are low and
  attractive returns hard to come by, this is an
  appealing story. Institutional investors and
  sophisticated private investors have queued
  up to get exposure to private equity and VC

funds.AccordingtodataproviderPrequin,

citedbyBloomberg,thebigplayersstarted

2020 withnearlyUS$1.5trillionin“dry

powder”(WallStreetjargonfor“money

sittingwaitingtobeinvested”);a record.

However,therushforunicornssuffered a

realitychecklastyear,astheventureend of

theindustrysufferedan“annushorribilis”.

Much-hypedIPOs,suchasUber,flopped

whentheycametomarket.Thebiggest

disappointmentcamewithWeWork. The

officespacerentalgroupwasscheduled to go

publiclastyear,withitsmaininvestor,

Japan’sSoftBank,hoping it

wouldlistata valueof

US$47billion.Inthe end,

theIPOhadtobescrapped

whenit lookedasthough the

mostit couldfetchwould be

wellbelowUS$10billion.

WeWorkfounderand chief

executiveAdamNeumann

leftthecompanyand Soft

Bank had to step in with

emergency funding.

So is this it for the boom in

private markets? Not necessarily.

Plenty of deals are still being done

atexuberant valuations. Shuli Ren,

forBloomberg Businessweek, notes that,

according to a recent study by Will Gornall

and Ilya A Sterbulaev published in the

Journal of Financial Economics, the average

“unicorn” is still priced at 48 per cent above

its fair value. With all that “dry powder"

flooding into funds that need to invest it

(you don’t pay VC and private equity fees to

have them stick your money in a cash

account), it’s hard to see the deal flow drying

up any time soon.

What does it mean for your own money?

You should be aware of two main points. If

you are considering investing in private

equity as an asset class, bear in mind that the

estimated returns to private equity are quite

possibly overhyped. Because companies

aren’t traded in public markets, private

equity valuations are more subjective than

those of firms trading on the FTSE 100.

REALITY CHECK

A good example of the difficulty of valuing

unlisted companies comes from Neil

Woodford’s fund empire. His flagship fund

was forced to stop investor withdrawals last

year because he held too many stakes in

unlisted companies that were impossible to

sell at short notice for the valuations

assigned to them. Since then, there have

been several write-downs on the value of

those firms, illustrating clearly that you only

know what an asset is worth once you’ve

managed to find a willing buyer for it.

The second point is more relevant if you

are tempted to buy into any of the IPOs of

the bigger VC-backed companies. The hefty

valuations put on some of these firms in the

private markets may not reflect reality. As

the JFE study points out, many late-stage

investors have protective clauses attached to

their investments, which will compensate

them if the IPO disappoints – protections

that ordinary investors don’t have.

While there may not be a bursting of the

unicorn bubble, any sensible investor should

view it as a warning sign. When you invest

in a sector characterised by high fees and a

lack of transparency, someone involvedin

the process may well make out like abandit

• but it almost certainly won’t be you.BT

You only know

what an asset is

worth once you’ve

managed to find a

willing buyer for it

The unicorn

bubble

Does the failure of some much-hyped IPOs signal

the demise of the start-up private funding market?