Path to IPO: Liquidity in Private Capital Markets
The route to IPO is a complicated one – especially given the current climate, as the economy slows and companies are under increasing pressure to scale while maintaining more modest financial constraints than they were previously afforded.
When a private company seeks to go public, it usually means one of three things: firstly, a company is seeking to raise capital; secondly, its board is planning to provide liquidity for investors and employees; and, finally, there’s a desire to raise brand awareness and strengthen market position in the eyes of potential customers.
The route to an IPO has often been seen as a key milestone in a company’s development in the global marketplace.
But in recent years – helped along by some regulatory changes and market factors – many companies are choosing to delay their route to the public markets and instead work on accessing capital through venture capital and growth equity investors to maintain their private company status.
Capital in private and public markets
According to Kevin Swan, Co-Head of Global Private Markets for Morgan Stanley at Work, these days the average time for a startup company, from launch to make the move to go public, is now over 12 years.
Swan, who studied as an engineer specialising in mechatronics – a multidisciplinary field that exists at the intersection of mechanical, electrical and computer engineering – got swept into the financial world through his early career experiences in startup companies. The path led him into venture capital and later to a company called Solium Capital, which was then acquired by Morgan Stanley in 2019.
Swan’s background has been instrumental in his understanding of the various reasons underscoring certain companies’ decision to choose an IPO route or remain as private entities.
The delay in going public, he explains, is mainly due to changes in the regulatory environment in addition to the flow of capital from public to private markets. This has resulted in private companies being able to raise significant capital without having to go public.
“Over the past decade, we’ve seen increasing amounts of capital flow into the private markets, and we’ve encountered several other factors that have led to this dynamic situation, where companies are now staying private for much, much longer.”
“Now, the average time to enter the public market for a venture-backed tech startup is much longer and these companies are valued in the billions, many in the tens of billions. Furthermore, some are able to raise enough private capital to not even necessarily need to pursue an IPO and rather enter the public markets through a direct listing.”
Even though it may take a company several years to reach the point where pursuing the public markets is a possibility, preparing for that process requires careful planning. Alternatively, while a company may wish to remain private, it may need to address its equity structure and liquidity strategy to ensure it remains an attractive option for its investors and employees as well as navigate the current economic climate.
Morgan Stanley at Work reshaping private markets liquidity
Although IPOs are generally considered the ultimate liquidity event, private capital markets are continuing to gain momentum in terms of investment interest. As a result, many companies are able to generate the funds required to provide employees with some liquidity on their equity packages, without going public.
These types of events, however – and the management of successful equity programmes – require considerable groundwork to be viable.
And that’s where Morgan Stanley at Work comes in: a division of Morgan Stanley that is focused entirely on private and public company share plan administration solutions that empower companies in providing employees workplace financial benefits. Their offering covers equity management, retirement solutions and financial wellness. For private companies wanting to maximize the benefit of their equity programmes, Morgan Stanley at Work offers a number of liquidity solutions.
Morgan Stanley’s day-to-day operations primarily consist of investment banking and financial services, so offering solutions that aid in the path to the public markets beyond raising capital has been a natural progression. As a global corporation, it is uniquely positioned to provide an equity management system for the private market that can facilitate recordkeeping, transactions, and money movement.
“If you're a public company, that infrastructure already exists in the form of transfer agents and clearing brokers, where you can easily buy and sell stocks in a public company online or through your financial advisor,” Swan says.
However, in the private marketplace, this can be more of a challenge, as historically speaking, there’s never been a highly sophisticated infrastructure to provide easy liquidity solutions. Morgan Stanley at Work is taking a progressive approach to solving that challenge by building a trading infrastructure and transaction execution framework that caters to private markets and is designed with an issuer perspective.
Specific protocols for private companies
Unsurprisingly, the private markets don't operate in the same way as public markets. Regulation is quite different, and the private investor community often has different objectives and time horizons than public investors. Morgan Stanley at Work offers Shareworks – an equity management platform utilized by private companies to manage their cap tables, employee stock plan and liquidity programmes. They have also launched a private market transaction desk that can help execute block sales and other forms of secondary transactions, giving shareholders access to liquidity and clients access to investment opportunities.
“We have the equity management platform and transactional capabilities to be able to support companies and shareholders,” Swan explains. “We also have an attractive investor client base for participation in liquidity events and secondary transactions.”
According to Swan, high-growth venture-backed companies control their cap tables, as ownership structures and the different legalities provide them the authority to decide who can be an investor – and who can't.
“The big takeaway is that these companies have a definitive say in terms of who can actually own their shares. So they want high-quality, reputable, long term investors on their cap table.”
Morgan Stanley at Work is fortunate to work with some of the best companies in the world, due to the full suite of wealth management and financial wellness offerings. These services empower companies to extend benefits to their employees, at the same time as engaging directly with both employees and investors.
“A lot of times, for employees in these startups, it's the first time that they've obtained any wealth. And whether that's a modest amount or generational wealth– which isn't uncommon at some of these startup companies – we have solutions and a large population of top financial advisors to support these employees on their financial journey.”
Managing the public versus private pathway
Sam Adams is the Executive Director of Private to Public Strategy for Morgan Stanley at Work. A veteran of the ‘route to IPO’ journey prior to joining Morgan Stanley, she managed a number of prominent IPO projects, which helped her to decide that managing share plan administration programmes and supporting companies through the process was the perfect use of her acquired skills.
“We have several private clients who have no intentions of ever going public and we're starting to see a larger trend in new clients who want to establish stock plans with regular liquidity activity already pre-programmed in,” explains Adams.
“This is because it gives them the flexibility to allow people to take some of the value that they've helped create in the company off the table through the shares they've earned as an employee, while not putting so much pressure on the overall company to have to make a decision of whether or not to go public within a certain time period.”
As someone who has witnessed first-hand the complicated process of the path to IPO, Adams is passionate about her role and says companies that manage their equity programmes well not only benefit themselves but in turn, also change the lives of their loyal employees.
“One of my personal missions in life is to make sure that capturing that opportunity doesn't get lost on other people. It really can be a life-changing thing, and Morgan Stanley at Work can not only help the company have the underlying infrastructure to make those transactions happen, but on the participant side, ensure that people have the right resources to take advantage of what that opportunity brings to the table.”
A developing trend in private capital markets
A good equity programme not only rewards employees but also creates a deeper investment culture within the organisation. If an employee can see the value of their shares rising as the company grows, it can incentivise them to work towards the company’s common goals. Equally, companies today may have to take into account lifestyle choices. Employees might have certain expectations in mind when they consider equity programmes at the job-offer level.
Today, as companies take longer to reach the IPO stage, they also have simultaneous opportunity to scale and grow. This means they have to offer competitive equity stake value or risk losing out to the competition. The war for talent as we’ve known it for the last 10 years is beginning to slow, evidenced by the volume of layoffs, particularly in the technology sector. However, down markets may breed innovation because with mass layoffs comes a surplus of talented people that find themselves without work, have potentially realized some significant value from previous roles and are ready to solve new problems. Similar to companies that emerged in the aftermath of the 2008 financial crisis, Morgan Stanley at Work believes there will be a new period of innovation out of the current downturn as well.
Swan says: “One of the big drivers in the evolving approach private companies take towards liquidity over the last decade was the war for talent. Private companies have become much larger, but the draw for startups to attract employees was always in the equity. You knew that you were taking a job where you were going to be fairly underpaid from a market perspective in your base salary. However, you're going to have the upside of equity, which could create an asymmetrical outcome, financially, for yourself.”
But what happens if these companies stay private for longer? “Now, we have companies that are worth billions – even tens of billions of dollars and they're financially sound – and they’ve raised a tonne of capital. But as valuations increase, you obviously don't have quite the same upside in any new equity you receive as you did when you were a small startup worth a few million dollars,” Swan says.
He goes on to explain that a shift has occurred, where these companies have to start paying more competitively on base salaries. But, they may also have to be competitive on the equity front. And very often in these cases, private companies are competing with large public companies.
“So, if I'm a senior engineer looking at joining one of these late-stage private companies and I've got an offer from them and I've got an offer from one of the world’s leading public tech companies – they may be very similar in terms of the base salary, and even the value of the equity I'm getting. But one big difference is that in a public company, when your equity vests, you can immediately sell it on the public markets. You have access to a liquid market.”
At a private company, the options are more limited. Swan establishes that this is where Morgan Stanley at Work comes in, following a growing number of private companies that have started becoming more proactive in providing liquidity to compete with public companies. Just over the past three years, it's a much more commonplace approach for large companies to take.
Offering access to value through private equity programmes
Current financial instability is another reason for employees to demand greater value and security from their companies, says Adams, highlighting that the need for better equity packages has probably never been greater.
“In terms of what's happening economically, I think liquidity is even more important because people don't have access to as much capital. Credit is far more expensive; inflation means that your money doesn't go nearly as far as it did a couple of years ago.”
“But people still have real needs to manage their lifestyles, and that can look like buying a home or paying for education for children. Your day-to-day life in this environment now means that it's harder to meet those same financial obligations. And so, if you have equity and you have all this value sitting on the side lines, people want access to it. They need access to it now, probably more than they have in the last 5 to 10 years.”
Private market liquidity and the investment community in a downturn
Questions, however, remain. How do private companies fit into all this, particularly at a time when investment is activity low? And how can they generate enough capital to remain as competitive as their public counterparts?
Adams says it all comes down to arranging the right types of liquidity events and setting up a strong framework.
“As an employee, you've been helping generate value over the period that you've been employed, and you've seen prices go up. Now, we're starting to see company valuations level out or go back down. But investors still believe in these businesses. Some of the economic factors at play here are not necessarily because these businesses aren't good businesses worth investing in.”
She points out that the tough climate doesn’t mean investing opportunities won’t happen; rather, in some ways, the opportunities are greater. “It's an interesting opportunity for investors who have probably been sitting on the side lines when valuations were higher and saying, ‘That price point feels too high for me to start to get involved’, and take positions in companies that they truly believe in at a price that seems a little bit more reasonable and sound, and start to be able to play the long game.”
Private market liquidity can be beneficial
Not going public but enabling employees to gain value from their stocks can result in gains all around, without the demands of going public. For example, if a group of two or three investors is looking to take a position and a group of 100 employees is ready to sell to them, it reduces the number of shareholders on the company’s cap table.
“This can potentially be really beneficial to all parties,” Adams states.
She points out that the benefit of gaining liquidity works on two levels for companies. Firstly, by letting them sell directly to an investor, they are allowing liquidity for employees without dilution. The process also provides an opportunity to clean up the cap table, the records of stock ownership, and reduce the number of actual shareholders.
One downside, however, is that the process may force companies and individual shareholders to come to terms with the delta in current valuations versus where they were a year ago. The gap in valuations from a company’s last fundraising round and what investors are willing to pay today is widening in private secondary markets.
“Something that we think our clients are still coming to terms with is taking the hit on price now and knowing that, if this is a good business, it will outlast the market conditions that exist today,” she says.
Investing in Private Companies
From a venture capitalist perspective, the situation can be complicated. They want to maximize the valuations in their existing portfolio companies while entering new ones at what they deem as fair valuations. VCs carry out their own valuation models on what future valuations of certain companies will look like, generally built on revenue multiples, growth rates and unit economics. But, there is also an element of volatility in share prices, depending on competitive dynamics and the market’s climate.
Added to that is the current, ongoing economic downturn – though this will almost certainly self-correct at some point, with Swan explaining that “the venture capital market is very cyclical”.
“Even compared to other financial markets, it has the highest highs and the lowest lows when it comes to valuations.”
For example, just over a year ago, secondary investors would pay a premium on the last round that a company raised.
“Now, we're in a different macro environment and talking about the discounts on the round an investor would pay. What's interesting or unique is that it's been so long since we've had one of these downturns. The market has been relatively stable for a decade. So there's a whole generation of people operating in this market that have never experienced a recession. Also, 10 years ago, we didn't have these massive private companies, liquid secondary markets, and large amounts of private capital available; it's uncharted territory for everyone. But, like any market, it'll figure itself out in the long-term.”
The future for Morgan Stanley at Work
Due to Morgan Stanley at Work offering a unique service via the provision of a clear and managed path through both IPO offerings and private liquidity services, the future's looking bright. Adams explains that, very often, these processes are messy and rushed. But when a dedicated team can guide a company through the regulatory and transactional minefield, it can be an invaluable service.
Furthermore, many companies are now turning to the service because they want to be ready and prepared in the event of an IPO. Equally, though, they would like the support of an expert team when it comes to managing their private equity programmes, too.
“If you're a corporate company and you're issuing equity to raise money or leveraging stock as part of your compensation programme then it's really important to continually connect the dots between your investor community, your board of directors, and your employee base,” she says.
Adams stresses the importance of understanding the needs of different groups and elements that are going to propel the business and provide liquidity for people while still potentially scaling to be a public company, “whether or not that ends up being the final result”.
“Sometimes it's M&A; sometimes it's staying private; and sometimes it's going through an IPO process,” Adams outlines. “For us, I think the next 12 to 18 months are really focused on making all of that easier for corporate clients. If it's easier for them, then it should be a better experience for their investors and their employees.
And working with a brand like Morgan Stanley at Work for such heavyweight decisions also has its merits.”
“Trust and reputation are a really big deal. Typically, when a company decides to embark on the path to IPO, they may only give themselves three months to manage the entire process. It can be messy and disorganised, because there are just so many bases that need to be covered. And then, once they reach the IPO, all that must be managed on the other side of the event, too. It’s not a process that suddenly ends when the company is public.”
In relation to this point, Adams notes that companies thinking about their route to IPO may begin preparations a good 12-months in advance to give themselves time to organise everything. She also says that many companies are using Morgan Stanley at Work to get their financial ducks in a row, so that if they do make a last-minute decision to go public, they can do so at short notice and be in their best shape.
“It alleviates a bunch of the pressures that companies start to feel as they approach a large liquidity transaction, like a tender offer or IPO, because they have trusted partners within the Morgan Stanley at Work umbrella. You can help give people resources to make good smart decisions.”