Jan 2017 by Caroline Rasmussen
Private companies commanding valuations of over $1 billion have earned themselves a new moniker, with references to “unicorns” and even “super-unicorns” (companies with valuations above $10 billion) saturating the investment press in recent years. Where did this massive growth in private value, particularly in the tech sector, come from?
Companies considering an IPO over the past few years have increasingly opted for an attractive alternative – the private market. For example, cybersecurity company Blue Coat dual tracked IPO and private sale processes last year, ultimately electing to be acquired by private company Symantec for $4.65 billion just two weeks after filing for an IPO. 1
Raising capital from private investors has been possible at about the same, or arguably better, valuations than the public markets have been offering, without any of the onerous disclosures required of public companies. 2 Listed companies are required by the SEC to issue annual reports and other documents containing extensive information about their finances, key operating metrics and strategies. In contrast, private companies are not required to give any information to the public, avoiding not only the associated expense and hassle but also protecting the confidentiality of their information.
In addition to sidestepping the regulatory reporting burden, staying private allows companies to pursue aggressive growth plans and restructurings that can be difficult to accomplish under public market scrutiny. Quarterly earnings announcements are highly anticipated and heavily researched by Wall Street, and public market investors do not hesitate to quickly punish companies that fail to meet their earnings-per-share guidance. Certain value-adding strategies can take years to successfully execute and may require an increase in short term costs at the expense of short term profits, making them difficult if not impossible to implement under public market pressure. Michael Dell famously cited the “90-day shot clock” when describing why he took Dell private as the company pivoted from retail computer hardware towards the enterprise market. 3
Finally, it is worth making the obvious observation that young startups are generally not revenue positive, a fundamental criterion for traditional public equity investors. But it is these nascent enterprises, rather than established companies, that have been the key drivers of value creation in the tech sector in recent years. As the next generation of Snapchat and Uber look to obtain fresh capital, the enhanced operational flexibility that staying private can provide will remain very appealing. Of course, both the private and public markets undergo cycles, and when the availability of private capital at attractive valuations begins to wane, we are likely to see a return to the public markets. But until then, expect more than the occasional glimpse of a unicorn.
Public market investors benefit from a regulated marketplace that enforces quarterly and annual corporate disclosures and provides daily pricing transparency and liquidity. In contrast, private market investments can be illiquid for indefinite periods of time, meaning they cannot be sold, transferred or redeemed at will or for reasons of hardship. Moreover, the frequency and accuracy of any private company disclosures are not monitored by regulators under the extensive framework that applies to public security issuers. Investors may lose part or all of their principal. Past performance is not indicative of future results.
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