Today Private Equity does not sufficiently leverage the opportunities offered by Capital Markets and an IPO as a next step, writes Søren Bjønness in an essay for finews.first.
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There is currently a strong and populistic view of Private Equity «taking over» the ownership of the economy. Even Private Equity professionals and consulting companies have this perception. It is good that Private Equity has grown and can support companies through various transitory situations. Yet, regarding the current utilization of private capital as a trend away from public capital would be more than extravagant.
At the end of 2016, Private Equity represented less than 4 percent of Public Equity in Euro terms. Data shows the value of companies on Public Equity markets has constantly increased over the years. The decreasing number of companies metric cannot truthfully reflect the growth of Public Equity. In fact, Public Equity companies are generally more mature and organically geared towards consolidation.
A number of misrepresentations comparable to the above undermine general understanding of the equity financing landscape. Often encountered, there is also a misconception about a reporting and regulatory burden that would be prohibitively larger with Public compared to Private Equity. The reality is that Private Equity investors are much more burdensome than Public investors can be. That is their self-understanding, considering they minimize risk-sharing.
«Structures are often very complex and barely understood by the targeted management»
Transparency, sometimes mistaken for causing short-termism, is prejudice too. Quarterly reporting is often considered to be at the root of short-termism in business. Besides, the European Union doesn’t prescribe it anymore on capital markets. Both Private and Public Equity demand diligent completion of accounting and auditing and you understandably need to emphasize investor relations if you are traded publicly.
Another strong misbelief is that the Principal-Agent problem is seen as more important in Public than in Private Equity: If well understood, the incentive structures in Private Equity can be very motivational, suited to the exceptional situations companies financed in this way can be in. In theory, there is a high symmetry in interest and knowledge between management and owners. In practice, structures are often very complex and barely understood by the targeted management, questioning their effectiveness. Indeed, we observe comparable incentives across Public and Private Equity. When comes time for Exit, the challenges of Principal-Agent vastly increase again, to Private Equity’s detriment.
«Professionalized and trimmed Private Equity portfolio companies make excellent IPO candidates»
What can be learned out of these considerations? Today Private Equity does not sufficiently leverage the opportunities offered by Capital Markets and an IPO as a next step. In the natural life cycle of a company’s growth, one expects Private Equity to be a «feeder» for Public Equity. Private Equity is organically exit driven as opposed to Public Equity. Yet, the IPO as an exit route is far too seldom explored. A «dual track» IPO/Tradesale realization process should be the norm. Professionalized and trimmed Private Equity portfolio companies make excellent IPO candidates.
In a mirror effect to the success of Nasdaq in the U.S., an increasing proportion of European tech companies financed by Venture Capital funds are using Capital Markets to stay independent and accelerate their growth. Euronext is a pioneer for this development in Europe. Europe should foster strong Public Equity Tech giants to counterweight the American and Chinese dominance. Usually, only Public Equity can provide massive financial resources and broader distribution of risk needed.
«Public Markets need to work more closely with Private Equity to ensure optimal equity financing»
Vice-versa: Public Markets need to work more closely with Private Equity to ensure optimal equity financing in Europe. The borders between these two worlds need to become smoother, opened. There should be more PIPE (Private Investment in Public Equity). And, companies can be «taken private» to address a special situation and value mismatch. A convergence of Private and Public Equity is a sign of maturity in financial markets.
There is a time for Private Equity and a time for Public Equity, even in the world of Private. It is a desirable thing to see enchanted Private Equity markets, they fulfill a very important financing role. Capital Markets stand prepared to continue accompanying Private growth stories when the time comes ripe.
Søren Bjønness knows both the Private and Public Equity worlds. His professional life has included stations in Banking, MBOs, Growth Financing, Incubation, Venture Capital, Corporate Finance/Capital Markets and interim management of Private Equity owned companies. He joined Euronext two years ago as Swiss Representative in order to motivate Swiss Tech companies to use Capital Markets more.
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