How do IPOs impact the market for venture capital and private equity?
An initial public offering (IPO) is the process of offering shares of a private company to the public for the first time. An IPO allows a company to raise equity capital from public investors, who can buy and sell the shares on a stock exchange. The transition from a private to a public company can be an important time for private investors, such as venture capital (VC) and private equity (PE) firms, to fully realize gains from their investment as it typically includes a share premium for current private investors.
VC and PE firms are specialized investors that provide funding and expertise to startups and high-growth companies, often amassing sizable stakes in exchange for equity or debt.
VC firms often take part in funding rounds for early-stage companies, while PE firms sometimes invest in later-stage companies or acquire them through leveraged buyouts.
A successful IPO by a portfolio company can unlock huge returns for VC and PE firms, as well as provide them with liquidity and reputation benefits.
The IPO market in the past year has delivered some strong debuts for growth companies, especially in sectors such as technology, biotechnology, e-commerce, and fintech. Many of these companies couldn't have come to market without the help of VC and PE firms, who supported them through various stages of development.
According to data from Prime Database, a primary market tracker, while there have been 25 companies that listed on the bourses in 2021, as many as 10 of those saw at least one PE/VC shareholder diluting its stake by offering shares as part of the IPO.
Some notable examples include Zomato (backed by Info Edge India), Nykaa (backed by TPG Growth), Policybazaar (backed by SoftBank), Paytm (backed by Alibaba), Freshworks (backed by Accel Partners), CarTrade Tech (backed by Warburg Pincus), etc.
However, not all IPOs are equally beneficial for VC and PE firms. Some factors that can affect their returns include:
The timing of their exit: VC and PE firms may choose to exit partially or fully at the time of the IPO or hold on to their shares for some period after the listing. The optimal exit strategy depends on various factors such as market conditions, valuation expectations, lock-up periods, etc.
The governance structure: VC and PE firms may have different levels of influence over their portfolio companies' governance structure before and after the IPO. For instance, they may have board seats, veto rights, anti-dilution clauses, etc., that can affect their ability to protect their interests and monitor performance. According to a study, portfolio firms backed by foreign VC, PE firms incorporate more effective governance structures after the IPO than those backed by domestic VC, PE firms. Specifically, these firms are associated with smaller, more independent, and gender-diverse boards.
The competition: VC and PE firms may face competition from other sources of funding such as angel investors, crowdfunding platforms, corporate venture capital, etc., that can reduce their bargaining power and increase the cost of capital.
In conclusion, IPOs can have significant impacts on the market for venture capital and private equity, as they provide opportunities for exit, liquidity, and reputation enhancement. However,
the returns and risks for VC, PE investors depend on various factors such as timing, governance,
Therefore, VC, PE investors need to carefully evaluate their portfolio companies' potential and readiness for going public, as well as monitor their performance after the listing.