Pre-IPO Analysis: Intro to Private Market Investing
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The investing universe includes two parts that exist in parallel and Pre-IPO intersect on some occasions: the private and public markets. Public market investors benefit from liquidity, structured processes, easy Analysis: Intro access, and low transaction costs. However, in the private market, the upside potential in many cases higher than the public market, to Private although it is significantly harder to access and success. Market This paper is based on slides presented to business school students in the course “Selected Topics in Finance” in the College of Law and Investing Business, Israel in May 2020, by the writer Lior Ronen. This paper will cover the differences between the public and private Lior Ronen (@Lior_Ronen) market investing, the differences between private equity and venture Founder and CEO capital, the massive private equity growth of 2009 – 2019, private market valuations, funding rounds, definitions, and how it all Finro Financial Consulting started. What is Private Market Investing? they want, decide on, and meet the legal and regulatory The private market includes requirements. illiquid assets such as stocks in private companies, private loans, These days, when access to public different debt vehicles, and real market investing is easier than estate. ever through a bank’s website or a broker’s app, the private market Unlike the public markets investing is harder to access for standard securities, the private most people. Even though market has no standardized platforms like SharesPost, Forge securities. There are many Global, and EquityZen try to make conventions and common the private market investing practices. However, since private process smoother, simpler, and market transactions are private more accessible than before, transactions between two parties, transactions are still available for they can agree on any terms that Pre-IPO Analysis: Intro to Private Market Investing accredited investors only and What is Included In Private Equity? classic private equity (i.e., require additional legal, buyouts), it is essential to The private equity industry accounting, banking and advisory highlight its core strategies. is estimated to manage around services. $5.2 trillion in various strategies Venture capital invests in projects Not only that, the private market when most money is managed in in which there is a substantial investing includes non-standard buyouts and real estate funds. element of risk, typically a new or securities, limited public access, Venture capital that receives much expanding business. The rationale and high transaction costs of the attention drawn to private behind the VC strategy is to invest compared to the public market; it market investing accounts for as early as possible in new also less regulated. ~12% of the private market. initiatives to gain the highest possible return. Of course, these A public company is required to As a tech financial consulting returns are also associated with publish audited financials every firm, this paper will focus on the considerable risk. quarter, update the public on private equity industry's buyouts, every material change in its growth, and venture capital Private equity typically refers to business or event that might strategies. investment vehicles in which a impact the company’s financials, fund buys and restructures What is the Difference Between investors know the value of the companies that are not publicly Private Equity and Venture Capital? company, and the number of traded. Other strategies of private shares and the transactions made. First, venture capital is a equity, invest in businesses in a In the private market, a company subcategory of the private equity more mature and later stage than is not required to release financial asset class. Second, when VCs to take them public and data to the public. There are no comparing venture capital to legal obligations to private companies to update their Private Market Funding Rounds investors every period, and Investors Angels Seed Funds Early VC Late Stage VC financial data is not available in a Accelerators click of a mouse for potential Crowdfunding Private Equity Funds investors. Moreover, investors in Secondary Market Transactions Equity FFF Round Seed Rounds Early Stage Late Stage IPO Post IPO the secondary market, in which Angels Pre-Seed Series A (Inc. A-1) Series E Secondary Offering Accelerators Seed Series B Series F they purchase securities from Equity Post Seed Series C Series G Crowdfunding Extended Seed Pre-IPO Round other investors, not from the Pre Series A company itself, might have less Debt Venture Debt Unsecured loans OTC Bonds access to data about the company Income Share Agreements (ISA) Private Debt than other investors. Source: Finro Financial Consulting | finrofca.com Finro Financial Consulting finrofca.com Pre-IPO Analysis: Intro to Private Market Investing benefit from the significant around the world drove investors investment into the private equity upside. into riskier and less liquid asset industry. classes that generate higher Since private equity funds invest Pension funds, endowments, and returns. in late-stage startups, their check sovereign funds increased their size is typically larger than VCs. In the search for better returns private equity allocation further, than government bonds yielded, which increased available funds However, these days the classic investors poured money into for private market strategies, differences between PE and VC private equity funds in various inflated valuations, and attracted start to fade. strategies. At the same time, the even more investments and so on. PE Growth of 2009 - 2019 stock exchanges around the world Another event that impacted the experienced a significantly long Between 2009 and 2019, the private equity industry is the JOBS bull market that inflated aggregated amount raised globally Act of 2012. The Jobs Act, or The valuations of publicly traded by private equity funds increased Jumpstart Our Business Startups companies and directly impacted in ~2.76x. What drove this Act, is a law intended to encourage valuations in the private market. explosion in private equity funds? funding of small businesses in the United States by easing many of Global Private Capital Raised, by Fund Type the country's securities regulations. The JOBS Act defined emerging growth companies as a business that generate up to $1 billion in revenues in the last 12 months. These growth companies are eligible to file confidentially for an IPO and save them one of the noise and hustle in the IPO process. Source: Bain The bill also increases the number of shareholders that a company As valuations grew, private market may have before being required to The primary driver for this sharp investors benefited from high register with the SEC. The law growth is the post-global financial returns that drove even more defines the maximal number of crisis (‘GFC’) low-interest rates. shareholders in a private company The historically low-interest rates Finro Financial Consulting finrofca.com Pre-IPO Analysis: Intro to Private Market Investing to 2,000 investors with up to 500 prohibited the investment of KKR, (and other PEs) returns' of those to be unaccreidted pension funds in private equity. exceeded investors' expectations, investors. which attracted even more After the ERISA restrictions were investments into P-E from The result of the low-interest relaxed, KKR (followed by other additional pension funds (state world combined with the PE firms) where after the pension and municipal level), endowment increased valuations and the funds money. These were huge funds (universities), and later also support from the JOBS Act is that funds that managed billions of sovereign funds. private companies can grow larger dollars and yielded small returns. than before and remain private Today every pension fund, In the early 80s, Oregon PERS longer than they used to. university, sovereign fund, and (Public Employees Retirement high net worth individuals in the How Did It All Start? System), was the first significant world allocate some of their pension fund to invest in KKR. The first modern private equity money to private equity. fund was established within Bear The Oregon PERS investments How Investments In Private Market Stearns by Jerome Kohlberg, into P-E that started in the early Look Like? Henry Kravis, and George Roberts 80s are considered to trigger and in the early 60s focused on family- drive the massive growth of the PE These are private market owned businesses with cash flow industry. transactions. Investors and problems. Typical Structure of a Private Equity Fund The private equity activity of Bear Stearns quickly became the most significant player in the market, completing many high-profile deals in the metals, motors, and industrial sectors. In ’76 Kohlberg, Kravis, and Roberts left Bear Stearns to open KKR, the first modern private equity fund. In 1978, the US Labor Department relaxed certain parts of the ERISA restrictions, which until then Source: Finro Financial Consulting | finrofca.com Finro Financial Consulting finrofca.com Pre-IPO Analysis: Intro to Private Market Investing companies can build any financial Dividend Rights SAFE (Simple Agreement for structure they can think of for this Future Equity) The right of a shareholder to investment. receive the same dividend that Investor provides a certain Investments can be made through other shareholders of the same amount of funding to the a convertible bond, convertible class receive. That is, if one holds company at signing. In return, the shares, forwards, a combination common stock with no special investor receives stock in the of these securities or something features and the company declares company at a later date, in totally different. that each shareholder is entitled to connection with specific, a 9 cents per share dividend, the contractually-agreed on liquidity Investments can include plain- company cannot arbitrarily decide events. The primary trigger is vanilla terms or side-notes with to pay one shareholder any more generally the sale of preferred exclusive (and confidential) terms.