Capital Market Intersections: Time for VC Firms To Tap Public Markets?
The landscape of venture capital has witnessed notable shifts in recent decades, with some venture capital (VC) firms opting to tap public markets via initial public offers (IPOs). Molten Ventures (formerly Draper Esprit), for instance, listed on the London Stock Exchange (LSE) in 2016, as did Forward Partners in 2021. Such listings signal the potential that more VCs may consider tapping public markets as the sector scales up globally.
A number of fund managers in the private equity (PE) space are publicly listed. Among them are global investment major Blackstone; KKR which offers shares in its KKR Private Equity Partners Fund; SoftBank Investment Holdings, the Tokyo-listed parent company of the SoftBank Vision Fund; and Nasdaq-listed Carlyle Group, which specialises in corporate private equity, real assets, global credit, and investment solutions.
This is notwithstanding the possibilities emerging from the growth of digital securities and fund tokenisation across both the VC segment and the broader PE sector in recent years.
Tokenisation, the process of using blockchain technology to convert an asset or ownership rights to digital form, is generating substantial interest. An EY report highlights how investors are signalling a willingness to allocate 7% to 9% of their full portfolio to tokenized assets by 2027.
Notably, institutional and high-net-worth investors (HNWIs) are expressing interest in investing in tokenized alternative assets, with a particular focus on real estate and PE portfolios. PE majors in the US Hamilton Lane, KKR and Partners Group are already exploring tokenization. Meanwhile, in the VC space, 500 Global has launched the 22X Fund in 2018.
While stock markets are increasingly embracing the technology of tokenisation and digital assets, they also continue to be well-established and proven platforms, supported by mature regulations and numerous precedents. These traditional markets offer a proven regime with both advantages and drawbacks that VC fund managers should carefully weigh in their considerations.
History of VC IPOs
American Research & Development (ARD), founded by Georges Doriot — credited as the father of modern VC and the founder of INSEAD — founded in the aftermath of World War II, was the first listed VC firm. It experienced unique challenges as a publicly owned, listed closed-end investment company.
Regulatory constraints posed a hindrance for ARD, preventing the provision of equity stakes or options to its employees, including senior dealmakers within the firm and portfolio companies. This lack of incentive structures had a consequential impact on their performance in the long run, resulting in subpar outcomes that ultimately saw it acquired in 1972.
Founded in 1946, ARD successfully raised $3.5 million for a closed-end fund, with over half of the capital sourced from institutional investors. Early achievements were closely tied to its affiliations with MIT and Harvard.
Doriot, a Harvard Business School professor, played a pivotal role, and his teachings inspired prominent figures in the VC landscape. Figures in VC history that were among Doriots’ students and associates included Tom Perkins (Kleiner Perkins), Don Valentine (Sequoia Capital), Bill Elfers (Greylock Partners), Arthur Rock and Dick Karmlich (Arthur Rock & Company), Bill Draper, and Pitch Johnson (Draper & Johnson Investment).
Despite early challenges, ARDs 1957 landmark investment — a 70% stake in Digital Equipment Corporation (DEC) for approximately $70,000 — generated returns that exceeded 50-fold by 1971. This ultimately led to ARD’s sale to Textron in 1972. The VC firm’s overall return from inception to sale reached 14.7%, with DEC investment playing a pivotal role in this success, according to a Morgan Stanley research note.
In the context of startups and VC, the absence of public listing opportunities not only hinders companies from realising returns but also carries significant implications for startups and their investors, creating a substantial liquidity crunch. The initial public offering (IPO) market is a crucial mechanism for generating liquidity and supporting the growth trajectory of venture capital (VC)-backed startups.
Startups going public provide an exit for private backers and access to a broader capital pool, fostering national economic growth and employment growth. This capital influx fuels innovation, expands operations, and accelerates overall business growth, with newly listed corporations experiencing better revenue growth and less talent constraints compared to private sector counterparts.
IPO-generated liquidity allows early investors to realise returns, contributing to the venture ecosystem’s vitality and encouraging continued participation in the VC market. Robust IPO markets play a crucial role in economic development by channelling funds, fostering innovation, and enhancing market liquidity, contingent on effective economic policies and regulatory frameworks.
Liquidity crunches in VC ecosystems translate to disproportionate effects for specific sectors and verticals, especially those heavily invested in and under pressure to deliver returns. The absence of returns poses challenges for fostering future investments, slowing down long-term growth and innovation.
Additionally, verticals characterised by extensive development cycles face heightened challenges during an IPO drought. Disruptions in mobilising capital can impede progress, lead to setbacks in achieving critical milestones, and constrain the release of shareholder value within an organisation.
VC firms that transition to public status on the stock market enjoy several advantages. Going public provides a streamlined avenue for raising capital, allowing these firms to diversify their funding sources effectively. The ability to use shares as a currency in public markets facilitates acquisitions, attracting high-quality targets and fostering overall growth.
Moreover, the issuance of shares allows for the transparent valuation and liquidity of employee instruments, contributing to talent retention. Beyond financial benefits, a public listing enhances a VC firm’s profile, expanding its network of stakeholders and reinforcing its reputation. The move to the public sphere often results in improved corporate governance, heightened transparency, and an augmented valuation.
Public listings provide access to a diverse investor universe, spanning institutions, accredited, and retail investors across public and private capital pools. This enables significant capital raising beyond traditional private markets, enhancing corporate profiles, credibility, and attracting talent, portfolio companies, and strategic partnerships.
The public profile instils financial discipline and transparency, building confidence in investors seeking reliability. Such firms can better leverage tech ecosystems for network expansion and new opportunities.
However, transitioning to a listed company comes with drawbacks. Heightened regulatory scrutiny, increased compliance costs, relinquishment of management control, and reduced flexibility in strategic decisions and operations are significant disadvantages.
Public markets, with their inherent volatility, exert pressure on listed firms and introduce a level of uncertainty. Disclosure requirements, including sharing sensitive information, and heightened competition with other listed entities constitute additional challenges. There is also the added market that prioritises short-term returns, as well as exposure to negative sentiment during market downturns.
Positioning as a publicly-traded VC can also present valuation challenges, illustrated by the case of Singapore-listed Trendlines Group, which also trades in New York.
Focused on startups in Israel and Singapore, specifically in agricultural tech and life sciences, valuing a portfolio of tech startups proves more intricate than stocks with readily available price-per-share references. Unlike stocks, startup values are investor-driven, often rising with subsequent funding rounds.
In theory, Net Asset Value (NAV) aligns with market cap, representing the total value of held startups or stocks. However, practical instances may diverge, as Trendlines demonstrates.
Striking a crucial balance between diverse interests — founders, VCs, retail investors, and those with patient capital such as endowments, pension funds, state investors and insurers — is another critical aspect for VC firms contemplating a public listing.
This requires aligning management teams with the firm’s goals, investment stage, and preparedness, and strong capacity to engage with investors and financial media, due to how market sentiments impact share prices.
Capital Market Trends
In terms of performance, according to data from financial research firm Cambridge Associates, the U.S. Private Equity Index reported a robust average annual return of 10.48% over the 20-year period ending on June 30, 2020.
This outperformance was evident when compared to other indices, with the Russell 2000 averaging 6.69% per year and the S&P 500 returning 5.91% during the same timeframe. Notably, VC emerged as the top performer between 2010 and 2020, boasting an average annual return of 15.15%.
In the 10 years ending on 30 June 2020, the S&P 500 slightly surpassed PE, posting a performance of 13.99% per year compared to 13.77%. Despite this, PE still outperformed the Russell 2000, which had an average annual return of 10.50% during that period.
Despite such figures, there’s still plenty of debate around actual PE performance, with at least one analysis indicating PE has market performance comparable to microcap equity, which enjoy much better liquidity than PE.
A Boston Partners’ research note highlights how over time, value-oriented micro-cap funds often outperform private equity. From 1995 to June 2020, the US Private Equity Index rose by 716%, outpacing the S&P 500’s 255%. Yet, the CRSP Equal Weighted Microcap Index performed even better, growing by 740%.
This apparent outperformance by PE as an asset class at different times through the 2000s and 2010s induced excessive delistings. This was not helped by a structural shift to private markets, which served to highlight the drawbacks of lacklustre public markets.
A 2016 study reveals that PE firms leading privatisations significantly reduce citizen-investors’ exposure to corporate profits. This limits public participation in growth and profit-sharing opportunities, potentially diminishing confidence in business and entrepreneurship. The perception that corporate profits primarily benefit a select economic elite, including PE and VC investors, may erode support for policies promoting overall economic growth.
The long-term impact of delistings? Event chains leading to decreased investor participation potentially harmed aggregate investment, productivity, and employment. Therefore, managing excessive delistings is then crucial to navigate the delicate balance between the valuable role of PE and VC in capital markets and the unintended negative consequences for sustainable economic growth.
VC and PE fund managers entering public markets mirrors the historical evolution observed in the listing pattern of investment banks. Beginning in the 1970s, niche players pioneered listings, discovering both the advantages and disadvantages of this new regime.
Over decades, prestigious firms like Goldman Sachs went public in 1999, and the PE sector saw Blackstone in 2007 and KKR in 2010. Despite initial concerns about incentive structures, this trend persisted.
The 1970s marked a transformative era with the creation of the first index fund in 1976 and the rise of mutual funds. Advancements in automation led to the NYSE reaching 100 million trades in a day in 1982. Responding to changes, investment banks listed shares to access capital for technology. Goldman Sachs, maintaining a partnership structure, went public in 1999.
As the VC asset class scales up, it plays a larger role in global finance. Despite disadvantages, public markets offer access to deeper capital pools, attracting institutional and retail investors. This depth enables VCs to experiment with long-term models, using ‘permanent capital’ for patience, a paradox amid market volatility. In Europe, with fewer deep-pocketed institutional investors than the US, this trend could significantly impact venture ecosystems.
Conclusion
The decision for VC firms to go public involves a careful balance of potential benefits and drawbacks, shaped by the firm’s specific strategy, culture, and goals. While it opens new avenues to access capital, it demands strategic navigation of regulatory landscapes and market dynamics.
Coupled with the historical cycle of VC and PE fund managers listing, reflecting an evolution in financial markets that mirrors the past trajectories of investment banks and private equity firms, online brokerages, the advent of mobile phones and other technologies are has also expanded, enhanced and democratised access to capital markets among retail investors.
This is coupled with trading platforms, evolving regulations and the digitalisation of securities that enable access to and trading of private capital market assets. Financial centres like London, New York and Singapore, are strategically poised to capitalise on the potential influx of capital stemming from the entry of VC firms into public markets.
This surge in capital presents a unique opportunity to expedite the expansion and maturation of their respective venture capital sectors, concurrently fostering advancements in the financial services industry. This transformative potential extends to facilitating enterprise financing for entrepreneurial ventures, presenting a catalyst for innovation and growth.
Central banks and economic policymakers should incentivize VC and PE fund managers to actively engage with stock markets, providing an additional avenue for capital mobilisation. This approach offers the public sector advantages, bringing greater transparency and regulatory rigour to an often opaque financial subsector.
For VC fund managers, tapping into public markets expands their investment universe to include retail investors and provides certain advantages relative to their private sector peers. This strategy encourages a more dynamic and transparent integration of VC and PE activities with the broader financial landscape.
The opening of doors to public markets creates expanded avenues for venture capitalists and investment banks, eager to tap into a broader spectrum of financing options, including engaging with the retail investor universe. This intersection of traditional VC and public markets can foster a dynamism that drives both the innovation ecosystem and market evolution.
