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Are private markets redefining investment for Singapore firms?
THE Initial Public Offering (IPO) is well over 400 years old, tracing its inception to when the Dutch East India Company famously issued shares to the general public in 1602. As a funding mechanism, the IPO has endured major revolutions, economic cycles and world wars.
Little, too, has changed. The IPO continues to serve as an essential rite of passage in the corporate fundraising process, serving as a goal that many founders and early private investors work towards. Investment banks continue raising funds for companies in an outdated way, one where the underwriters, venture capitalists, and private equity firms win big. Public institutional and individual investors, meanwhile, remain none the wiser nor (comparatively) richer with limited access to and ability to get into these investments early.
Not surprisingly, recent performances of top exchanges suggest that being publicly listed could place companies in a worse position than before. In 2018, Hong Kong delivered the worst returns for listed companies in a decade, with the valuations of companies that raised at least US$100 million dropping an average of 6.2 per cent in their first month of trading. Global trade tensions also led to US$2.4 trillion being shaved off stock valuations in Shanghai as the year closed.
SHOULD MID-STAGE, HIGH GROWTH SINGAPORE FIRMS STILL AIM FOR IPO?
Raising capital through an IPO can be a long-drawn and tedious process, usually taking anywhere from six to nine months - or longer. The management team almost entirely focuses on the public offering, with roadshows and the likes taking precedence over other areas of the business. In addition, with the legal, administrative and other professional services fees, it is a rather expensive endeavour, often well over S$1 million.
Many deem an IPO as the goal post for a company to attain when in fact, it marks the beginning of a new journey, one that is no mean feat. Post-IPO, the company is expected to deliver on the promises made in the preceding stage - this is a key challenge where strong operational execution is required to maintain long-term success. Managing a large pool of stakeholders will be novel and hence difficult for many. This primarily involves the need for periodic communication and selling of the growth story to maintain investors' interest and confidence. All public companies are also subjected to strict compliance measures and reporting and disclosure requirements for accountability reasons, which increase costs.
DOES THE SGX CATER TO RISKIER INVESTMENT APPETITES?
Unfortunately, the SGX still caters to the stubborn preferences of an ageing investor demographic. As they age, investors that were previously open to more risky opportunities are choosing instead to hedge their bets on 'safer' options for wealth preservation. The SGX has not evolved to meet the expectations of a younger crop of investors with a high-risk appetite who are more inclined to invest in companies aligned with their personal values and passions.
These factors have skewed a preference towards Real Estate Investment Trusts (REITs) and Business Trusts. This diminishes the fundraising prospects for companies offering niche products or services as they are perceived to be riskier and thus less appealing to modern investors.
This trend also impacts the overall ability of investors to price growth. Beyond access to capital, companies launch IPOs to get a market assessment around their valuation. It is one of the reasons why many technology companies prefer to pursue US listings, citing a more robust overseas investor ecosystem. The traders there are used to pricing growth companies which is necessary to facilitate a successful tech listing. For example, a number of S-Chip companies exited from the SGX, with one of the key reasons being a lack of value and interest from domestic investors.
While some businesses may look at this as an opportunity to spread their wings, it may prove challenging on many levels. For instance, overseas stock traders may not have a coherent understanding of the company's product-market fit, or the commercial and regulatory environment the company operates in. This results in a lacklustre welcome to foreign companies.
A CLEARER FLUIDITY AROUND WHAT COMES NEXT
Other concerns that many companies choosing to IPO have is if they will have sufficient depth of liquidity (average daily trading value) to support follow-on rounds post an IPO listing. With the older generation of investors transitioning to yield-bearing investments and a younger generation who tend to invest more selectively (into companies aligned with their personal values and passions), the market-making ability and daily pricing are significantly reduced. Sometimes management can make poor business decisions due to increased pressure from shareholders and forgo long-term growth for short-term profits.
So, where do best-in-class unlisted companies raise capital efficiently?
According to Schroders, the number of US-listed companies has shrunk by around half over the past 20 years, with similar situations seen in the UK and parts of Western Europe. Concurrently, entrepreneurship is on the rise - on average, a whopping 21,000 new companies have been created in the US each year since 1996. Comparison of these datasets reveals one key trend: companies are obtaining capital from an alternative source.
The private market provides an ideal platform that serves as the "third option" for exits - a modern alternative from traditional IPOs and Trade Sale. And of course, it can be extended to fast-growing companies that are otherwise considered too small or unsuitable for listed markets, as well as early-stage and growth capital businesses.
Ben Narasin, New Enterprise Associates venture partner, explains that the growth of the private market is due to a continual inflow of enormous amounts of capital as a result of the entry of an ever-increasing number of players. With a constant focus on velocity and growth to validate whether a business can be of venture scale, there is a never-ending increase in prices that investors are willing to pay.
Several factors drive this trend, including the rise of many prominent deep-pocketed funds such as Softbank's US$100 billion Vision Fund, as well as an increased awareness of private equity as a financing option.
We're also seeing growing acceptance and popularity around private exchanges, which provide investors with access to investment opportunities into high-growth private companies. An example of such an exchange is the Nasdaq Private Market, which recently set a new record in transaction volume of US$12 billion for 2018, a significant jump from US$3.2 billion in 2017.
Seeking to emulate the success of the Nasdaq Private Market, a consortium formed by capital market intermediaries and emerging technology innovators across the Asia-Pacific has established Singapore-based Hg Exchange. Currently pending sandbox approval from the Monetary Authority of Singapore (MAS), the member-driven private market exchange will support the issuance and trading of private company shares, including security tokens, presenting shareholders of private companies with a single destination to monetise their stake.
PAVING THE WAY FORWARD FOR PRIVATE EQUITY
According to Bain, Asia-Pacific private equity has performed outstandingly in recent years, suggesting that private markets remain an extremely viable option. More public funds are looking to enter earlier into private companies but there is currently no structured platform or exchange that exists to facilitate this.
Change is upon us with the private market providing more and more compelling investment alternatives to individual investors. McKinsey estimates that private asset managers have raised near US$750 billion globally on the backs of investors allocating rising sums to private markets, driven by the low return environment that currently characterises public markets and pressure to perform.
Private investment platforms, by leveraging data and technology, are able to amplify the efforts of the fundraiser, matching them to a pool of investors with aligned mandates. This will help companies compare multiple-term sheets from investors, which in turn allows for effective and accurate price discovery.
Companies stand to gain in several ways by staying private. These include:
- Lower costs as a result of reduced auditing and compliance requirements, which can also contribute to increased privacy through a lesser degree of compulsory disclosure;
- Increased control over business decision making, and the ability to focus on long-term business goals as opposed to short-term gains for shareholder reporting.
Besides access to capital, such platforms also provide subsequent liquidity by helping early investors and eventually founders and employees monetise their stakes. Presenting an exit option upfront incentivises shareholder loyalty which motivates them to contribute to the company - the better the business performance, the greater the value of their personal stake.
As more middle-class investors enter the playing field, it is clear that private equity activity is set to grow in the Singapore market. While this does not sound the death knell for IPOs - with giants such as Pinterest, Lyft and Uber all preparing for potential IPOs in 2019 - technology innovation will continue to spur private equity markets to become even more accessible, alluring and popular among companies and investors.
- The writer is CEO and Co-founder of Fundnel