The IPO Drought: What does it mean for private investors?
By Carolyn Goard, Senior Communications Manager, Canadian Venture Capital and Private Equity Association
There’s no doubt the private capital industry has witnessed a decrease in initial public offering (IPO) activity in Canada over the last few years. Pinpointing solid companies to acquire (that will ultimately lead to a listing on a stock exchange) is like trying to find a needle in a haystack—making it difficult for investors to find viable acquisition targets.
Earlier this month, @GlobeSmallBiz published an article on the topic of IPO-worthy start-ups being harder to come by as a result of companies choosing to stay private and access capital through venture capital financing. More than that, fewer portfolio companies are ready—or willing—to exit these days.
These conclusions are no doubt consistent with the numbers. According to invest.com, the dollar values raised through IPO’s on Canada’s two exchanges since 2014 has dropped—significantly. Large cap IPOs on the Toronto Stock Exchange (TSX) dropped off a cliff in 2016, with only $.06 billion this year compared to $2.9 billion for the same period last year—a decline of almost 80 per cent. Small cap IPOs have also dried up since the second half of last year, with only $11.3 million in the last four quarters compared to $144 million raised in the preceding four quarters—a decline of more than 90 per cent.
These numbers may reflect the fact that private companies are simpler to manage than public ones. Some private capital investors are even purchasing public companies and turning them private. And, it’s sometimes easier to sell or exit by selling to a large public company and trading at a high multiple, than to become public by oneself.
We chatted with some Canadian investment funds to get their insights on why “IPO-worthy” start-ups may or may not be harder to come by and why more start-ups are ultimately choosing to stay private, longer. Here’s what we learned:
IPO reluctance not a new phenomenon
Companies choosing to stay private isn’t anything new to the private capital industry. When the trend was to “go public” early, many of these companies ended up failing or being worth nothing. What’s important to consider is that, firstly, the costs of an IPO and operating as a public company are steep and, secondly, it requires a significant amount of expertise, systems and advice to maintain a public company structure—and lots of companies just aren’t developed to this level. In the case of businesses that are growing well and generating results, spending money on going/being public isn’t the best use of those funds.
Plenty to consider
There are many things to contemplate when a company is considering going public as an exit strategy. Generally, in recent times, valuations on an M&A exit have been higher than in an IPO, and let’s not forget that in an IPO, the seller does not typically sell their entire position (the remainder of which will be subject to restrictions on when and how much may be sold after the IPO).
The IPO process is generally more involved, longer and more expensive than a private sale. We’ve seen many exits that run a dual process for exit. Once public, the company has more compliance obligations and there is more transparency of their activities, including significant and expensive reporting obligations as insiders must report holdings and any changes in holdings. There are also independence requirements, more formalized structures for governance, restrictions on the ability to sell shares and restrictions on the ability to negotiate investments or sales going forward due to the requirements of securities law and the exchange rules and regulations.
TSX IPO doesn’t equal exit for VCs
Not enough institutional funds investing in TSX-listed stocks are willing and ready to invest in “risky” tech stocks. Therefore, volume at IPO has been historically low. VCs can’t liquidate their positions and are sometimes forced to hold onto public stock for years after the IPO. On top of that, public valuations are lower (especially in Canada) versus private. And, it goes without saying that going public is expensive. Plus, you typically have to keep some stock under escrow for quite some time. If the issue isn’t large enough, you may just create an orphan type of company with limited float.
Moreover, for the entrepreneurs involved in that issue with a private equity investor, you may get aggressive speculators who don’t have the long-term vision of the business at heart, which is why many new issues have dual-class structures.
The good and the bad
So what does the decline in IPO activity mean in practice? For private investors, there are more opportunities to invest as the public markets are less accessible and public valuations are less onerous. They can also buy at lower multiples, but this of course, has an effect on the valuation for the entrepreneur. And a private investor who would like their investment to go public will also face a lower valuation when he exits.
While there are opportunities in any market environment, ultimately, when public markets are good and healthy it is generally good for all.