Jun 19, 2018 | Techcelerate Ventures |
THE EVOLUTION OF LIQUIDITY Shifting exit strategies for private market investors Page 14 2Q 2018 Private vs. public market investors: Who's reaping the gains from the rise of unicorns? Page 4 New horizons for PE Page 52 A SPOT of secondary activity Page 56 1 PitchBook Private Market PlayBook 2Q 2018 2 PitchBook Private Market PlayBook 2Q 2018 Perspectives Private vs. public market investors: Who's reaping the gains 4 from the rise of unicorns? Billionaires, buyouts and basketball: The Gores brothers 8 take on private equity Barbarians left behind: How predictive analytics are 12 upgrading PE's playbook A letter from the Editor 2 Contents 4 2 14 24 46 The Feature The evolution of liquidity: Shifting exit strategies 14 for private market investors As market dynamics change, investors within private equity and venture capital are finding new and diverse ways to exit their investments Market Trends US Venture Capital 26 US Private Equity 30 European Venture Capital 34 European Private Equity 38 Global M&A 42 Analyst Insights Sources of impact capital 46 New horizons for PE 52 A SPOT of secondary activity 56 Additive dealmaking 58 Twin Brook Q&A: Hot middle market lending environment 20 comes with competition and new challenges 20 a single-minded focus. pure valuation Pure valuation means that our well-credentialed professionals concentrate their expertise on getting to the right value for your organization that withstands scrutiny. Our focus goes beyond the typical modeling scenario and deeper into your firm’s strategic rationale to deliver objective, practical guidance to achieve your business objectives. The right valuation partner provides transparent, reliable, fair value reporting in an increasingly complex universe of investment and growth opportunities. Since 1975, VRC has delivered supportable conclusions of value to domestic and international clients of all sizes, types and across all industries. FIND OUT MORE AT VALUATIONRESEARCH.COM 2 PitchBook Private Market PlayBook 2Q 2018 Predictable outcomes through changing market cycles. And a certainty of execution that our clients have come to expect from a market leader. Through 20+ years of innovative financing, our consistency is what makes us different. Antares.com George Gaprindashvili Editorial Director CREDITS & CONTACT PitchBook Data, Inc. John Gabbert Founder, CEO Adley Bowden Vice President, Market Development & Analysis ©2018 by PitchBook Data, Inc. All rights reserved. No part of this publication may be reproduced in any form or by any means—graphic, electronic, or mechanical, including photocopying, recording, taping, and information storage and retrieval systems—without the express written permission of PitchBook Data, Inc. Contents are based on information from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. Nothing herein should be construed as any past, current or future recommendation to buy or sell any security or an offer to sell, or a solicitation of an offer to buy any security. This material does not purport to contain all of the information that a prospective investor may wish to consider and is not to be relied upon as such or used in substitution for the exercise of independent judgment. George Gaprindashvili Editorial Director Garrett James Black Manager, Publishing Caroline Suttie Production Assistant Nizar Tarhuni Associate Director, Research & Analysis Dylan E. Cox Senior Analyst James Gelfer Senior Analyst Kyle Stanford Analyst Cameron Stanfill Analyst Joelle Sostheim Analyst Kevin Dowd Associate Editor Alex Lykken Senior Analyst Dan Cook Manager, Analysis Bryan Hanson Senior Data Analyst Masaun Nelson Data Analyst Darren Klees Data Analyst Henry Apfel Data Analyst Andy White Senior Data Analyst Eric Maloney Graphic Designer Jennifer Sam Senior Graphic Designer Joshua Mayers Senior Editor Amber Hendricks Senior Copy Editor Kate Rainey Editor Contact PitchBook Content editorial@PitchBook.com Advertising andrew.doherty@PitchBook.com Private Market PlayBook A letter from the Editor Private equity and, to an extent, venture capital can be seen as relatively stagnant industries, utilizing core investing strategies that haven’t changed much in decades. But these industries have actually evolved dramatically over the last few years, not just from the perspective of overall market trends but from that of investors. Of course, by “investors” we’re referring not only to the general partners (GPs) that make the deals but also to the limited partners (LPs) that fund the GPs, and even the employees who invest years of their life to help grow companies. Considering PE and VC are highly illiquid asset classes, one of the biggest challenges for fund managers is executing the right strategy to achieve an exit and return capital to themselves and their investors, the LPs. And for LPs, the biggest concern is getting a return on their investment in a reasonable amount of time. The path to liquidity has shifted rather significantly recently. Massive capital availability in the private markets has contributed to lengthening company lifecycles and investment hold times, and sky-high valuations and deal multiples have driven exit volume down, to name a couple factors. Investors have weathered these market shifts and have found new and diverse ways to achieve liquidity. As companies stay private for longer, activity has grown in direct secondary markets, which has fostered enhanced liquidity for investors and employees in ways we haven’t seen before. This has also enabled enhanced price discovery, which in turn has fueled innovation in listing mechanisms, such as Spotify’s recent direct public listing. LP secondaries have proliferated and GPs are buying these stakes at an unprecedented clip, no longer seeing these transactions as a red flag. Moreover, there’s been a considerable rise in GP stake deals, which provide liquidity to GPs by selling minority positions in their underlying management companies. The feature article in this issue of our magazine outlines the approach and drivers of some of these shifting strategies, highlighting the evolution of liquidity through the LP, GP and transactional perspectives. This issue’s liquidity theme also comes through in the Perspectives section, where we compare the value creation of public and private unicorns to see who’s reaping the gains from their rise. Finally, in the Analyst Insights section we dive deeper into Spotify’s innovative listing and its potential implications. Cover illustration: Alessandro Gottardo 5 PitchBook Private Market PlayBook 2Q 2018 4 PitchBook Private Market PlayBook 2Q 2018 Perspectives Private vs. public market investors: Who's reaping the gains from the rise of unicorns? By Adley Bowden, Andy White 729.3 337.8 303.8 102.3 73.9 71.6 18.7 17.3 14.8 10.4 0 100 200 300 400 500 600 700 800 Facebook (FB) Workday (WDAY) Wayfair (W) Twitter (TWTR) FireEye (FEYE) Zynga (ZNGA) Groupon (GRPN) GoPro (GPRO) LendingClub (LC) Leaf Group (LFGR) Average monthly market cap index by time public Source: PitchBook *As of May 9, 2018 A slow drama is currently playing out that’s radically altering the financial market landscape: the number of publicly listed companies in the US is steadily shrinking. This trend has raised alarm bells across Wall Street and attracted attention from policymakers and capitalists alike. From our vantage point as a data and information provider on the private markets, we believe this is evidence of an ongoing transition into a new capital markets paradigm that includes a significantly more robust institutional private market. To better understand this change we decided to look at a prominent collision point of this paradigm transition—IPOs and unicorns, which are defined as privately venture-funded companies with valuations of $1 billion or more. That unicorns exist, let alone flourish with 240 globally when this story went to print, is just one of the facts we submit in support of this shift. We’ll save the full manifesto on the new paradigm for a future edition of this magazine and, until then, share what we found as we pored over our data on unicorns and IPOs. Not your 1990s’ IPOs For ease and consistency of analysis, we focused on US- headquartered, venture-backed technology companies, and what we found confirmed some of our hypotheses, overturned others and opened our eyes to new ideas. One trend that has been inarguable is venture-backed companies staying private for much longer than ever before. Since 2010, companies have been going public more than nine years after founding, compared to around five years in the mid to late ‘90s. That increase has meant these companies have gone public at a very different stage in their lifecycles—they’re much larger, they’re more sophisticated, they have a larger investor base and they're often global in reach. It also means that there are fewer of them, as it’s a lot harder to stay in business and/or independent for nine years versus five. There are several drivers behind the trend of staying private longer, and a few commonly cited causes are the increased cap on investors from the JOBS Act (from 500 to 2,000), new deep-pocketed entrants into the venture market (e.g., SoftBank Vision Fund, PE firms, mutual funds) willing to fund nine-figure investments into these companies, and SOX compliance expenses. Another interesting theory put forth by Dr. Jay Ritter (aka “Mr. IPO” from the University of Florida’s department of finance) is that private companies are moving so fast that a better route for them to reach their potential is to be acquired by an incumbent with scale, as opposed to building it themselves. We also believe many founders are intrigued by the relative freedom of the private markets, versus the scrutiny—and quarterly targets— demanded by public markets. As long as these factors stay in place, we don’t foresee the current IPO timeline changing. Which investors see the value? Some of the world’s most highly valued public tech companies entered the public markets with quite modest valuations, at least by today’s standards. Microsoft, Amazon, Oracle and Cisco all debuted with market caps south of $1 billion. Of those, only Microsoft topped $500 million. This translated to relatively modest gains for their private market investors, compared to the massive value appreciation they have all experienced post-IPO. By comparison, the current crop of unicorns is creating massive gains for their private market investors. When we first started compiling data for this article, we had a hypothesis that delayed IPOs meant a greater portion of the financial value that unicorns generate was being captured by private market investors instead of their public market counterparts. That turns out to be mostly the case but isn’t exactly the full truth. The reason being that the power law dynamic of venture investing economics carries through into the public markets post-IPO. For this analysis, we started with 10 tech unicorns in the US that went public between 2009 and 2014 (for at least three years of trading data). We based their market caps at IPO to 100 and then charted their average monthly market caps up to May 9, 2018. We were surprised to see that only four of the 10 are currently valued above what they were at their debut. This means that, to date, six companies reached their peak valuations within the private markets and have only declined in value for any public market IPO investor. If you had taken $1,000 and invested $100 into each of these companies at its IPO, you would have $1,679.88 today. Not a terrible return, but not great. The interesting reality is that 58% of that gain comes from just Facebook. Then 22% from Workday, 18% from Wayfair and 0.2% from Twitter. If you had instead invested that 7 PitchBook Private Market PlayBook 2Q 2018 6 PitchBook Private Market PlayBook 2Q 2018 Private valuation appreciation by year $31M $43M $71M $153M $169M $172M $201M $375M $378M $456M $471M $492M $500M $551M $560M $585M $597M $695M $707M $761M $839M $893M $1.0B $1.1B $1.3B $1.3B $1.3B $1.4B $1.4B $1.6B $1.6B $1.9B $2.7B $2.8B $3.4B $3.6B $3.9B $7.8B $9.8B Oracle Cisco Systems Microsoft Amazon.com Box Etsy Tanium GreenSky Apple Houzz Charter Communications Akamai Technologies Outcome Health Red Hat Machine Zone Slack Technologies Wish Instacart SoFi Dropbox Moderna Therapeutics Magic Leap Lyft VMware Pinterest Samumed Stripe Zenefits Zynga SpaceX Palantir Technologies Twitter Snap WeWork Groupon Airbnb Alphabet Uber Facebook Currently private Currently public Source: PitchBook *As of May 9, 2018 -$5.2B -$1.5B -$587M $543M $544M $650M $1.4B $2.1B $3.4B $4.1B $5.8B $7.8B $23.0B $24.3B $25.6B $37.0B $51.8B $72.4B Snap Groupon Zynga Box Akamai Technologies Etsy Red Hat Twitter Charter Communications VMware Oracle Cisco Systems Microsoft Apple Dropbox Amazon.com Alphabet Facebook Market cap appreciation by year Source: PitchBook *As of May 9, 2018 $1,000 in just Facebook, it would be worth $7,292 today. A sample size of 10 isn’t exactly exhaustive enough to draw solid conclusions from, but it certainly raises some questions about unicorn IPOs and to whom the gains accrue. How today’s unicorns stack up To get a better sense of private market value creation, we took a group of private tech unicorns in the US and divided their most recent private valuation by the number of years from founding to latest financing. This shows us how much value is being created per year private, while accounting for companies that have been private longer, and thus have had more time to accrue value. We also selected a group of public tech companies and used their market caps on the day of IPO, then dividing that by the time from founding to IPO. Here are the results: Uber is the only current unicorn that comes close to Facebook’s rate of value gain as a private company, possibly boding well for the ridehailing company’s planned listing next year (or beyond). The remainder of the group shows an interesting trend: the companies having accrued private value the quickest tend to be younger companies, while the legacy tech titans accrued relatively little value while private. Amazon, Microsoft, Cisco and Oracle are barely visible at the bottom of the chart, yet all currently have market caps over $150 billion. As a comparison, the billions of dollars in value accruing these days to private investors is staggering. So, clearly the private market investors are profiting significantly more than public investors, right? Wrong, kind of. Again, a mixed picture emerges where the top companies only accelerate in the public markets, accruing significantly more value to the public markets than the private ones. However, there is a larger number of companies that see marginal or even value destruction while in the public markets. Clearly, Facebook is in a league of its own, but we also see the true explosion in value that the legacy tech titans have enjoyed since being public, dwarfing even Facebook’s value gains while private. We also see that some of the more recent entrants into the public arena have not fared so well. To be sure, it’s still far too early to make a definitive judgment on many of these businesses, but it does beg the question: Have some companies exhausted their potential value growth in the private markets? Our original hypothesis was that the changing paradigm between the public and private markets means that private market investors are capturing a significantly larger chunk of venture-backed companies value creation than in the past, and potentially even more than public market investors. It turns out, like most things in life, it’s complicated. For many companies, that looks to be the case—causing us to be suspect of the ultimate performance of many of today’s unicorns, should they go public. There are a select handful of unicorns, however, that will emerge from the private markets with the scale and momentum to only accelerate their growth post-IPO and bring with it majestic returns to their public market investors, as well. 9 PitchBook Private Market PlayBook 2Q 2018 8 PitchBook Private Market PlayBook 2Q 2018 Billionaires, buyouts and basketball: The Gores brothers take on private equity By Kevin Dowd Who’s the most interesting person in private equity? That’s open to debate. Who are the most interesting brothers? To that question, we have an answer. Alec and Tom Gores are both the founders of their own firms: Alec leads The Gores Group, while Tom is the CEO of Platinum Equity. The pair are also the owners of two of the largest homes in Los Angeles: Alec has an 11-bedroom mansion on 2.2 acres in Beverly Hills, while Tom bought a palatial estate in Holmby Hills in 2016 as part of a reported $100 million deal. In his spare time, Tom’s activity of choice is basketball. He’s been the owner of the NBA’s Detroit Pistons for the past seven years and has become a major presence within the franchise, often sitting courtside at its shiny new arena in downtown Detroit. Alec, meanwhile, is said to prefer a different game. In 2012, The Daily Beast reported he lost $17.4 million to an Irish gambler in a “serious backgammon match” that spanned three days. With a net worth of $2.1 billion, per the latest Forbes estimate, he can afford it. Forbes assigns Tom a net worth of $3.9 billion, giving the brothers a combined value of an even $6 billion. And did we mention the wire- tapping? A dozen years ago, Alec and Tom were at the center of a federal investigation of a private investigator in Hollywood, when reports emerged that Alec had hired the PI in 2000 to determine whether his wife at the time was having an affair with Tom. The detective had proceeded to install listening devices on the pair’s phones, and Alec’s suspicions were reportedly confirmed. Neither Gores Group nor Platinum responded to interview requests, and neither brother is known for being an open book with the media when it comes to their private equity activities. But the Alec and Tom still manage to make their share of headlines. And lately, so have their firms. * * * The Goreses were born in Israel— Alec in 1953 and Tom in 1964— and moved as kids to Michigan. (A middle brother, Sam, is the chairman of Paradigm Talent Agency. The Gores genes aren’t effective only in private equity.) Growing up in the Rust Belt was a far cry from the brothers’ future positions in Hollywood’s upper crust. And it wasn’t long before they began showing a desire to transcend their humble beginnings. Alec founded his first company in 1978, dealing computers out of their parents’ basement, and sold the business eight years later for some $2 million. A career had begun. The next year, in 1987, he founded The Gores Group, making the move from selling products to selling companies. His younger brother followed suit eight years later, launching Platinum Equity in 1995. These days, Platinum is the larger firm—it boasts $13 billion in AUM compared to about $2 billion for Gores Group—and generally pursues larger deals. But both firms are operationally focused, seeking out investments that allow in-house teams to use their expertise to create value. Tom Gores and Platinum completed 20 new investments last year, their most since at least 2006, according to PitchBook data. The firm continued its buyout spree during the early months of 2018, executing 11 transactions during 1Q alone. That ranked in the global top 20 for activity during 1Q and put Platinum on pace to more than double last year’s firm record. The biggest price tag from those 2018 deals was the takeover of Husky Injection Molding Systems from Berkshire Partners and OMERS Private Equity in an SBO worth $3.85 billion. To finance that increase in activity, Platinum is ascending to new fundraising heights. The firm closed its fourth flagship fund on a $6.5 billion hard cap last March, representing a 73% step-up in size from its $3.75 billion predecessor, a rare increase for a firm that’s already raising billions. Things have been a bit slower on the investment front at Gores Group. Alec’s shop completed six new deals last year, per PitchBook data, down from a recent high of 14 in 2014. But the firm has been active in other ways. Reports emerged in February that Gores Group planned to forgo raising a new fund, opting instead to gather cash and invest on a deal-by-deal basis. Not long before that, the firm was involved in an unconventional deal that departed from the normal paradigm of private equity—and that played a role in the revitalization of one of America’s most iconic brands. * * * In 2012, Hostess Brands was on its death bed. Weighed down by debt from a buyout gone bad, the company shut down its operations entirely and auctioned off its assets. The next year, though, an investor group bought several of the company’s major brands—including Twinkies and Ding Dongs—for a reported $410 million. And three years after that, Gores Group lent a hand for the next stage of the rebirth. Founder Founded HQ Other offices 2017 investments* 1Q 2018 investments* 2017 exits* Alec Gores 1987 Los Angeles Boulder, CO 6 0 3 Tom Gores 1995 Los Angeles Boston, Greenwich, CT, New York, London, Singapore 20 11 3 *Source: PitchBook 11 PitchBook Private Market PlayBook 2Q 2018 10 PitchBook Private Market PlayBook 2Q 2018 In November 2016, a special purpose acquisition company sponsored by Gores Group acquired Hostess and took the company public through a reverse merger. Coming with a reported valuation of $2.3 billion, the move allowed Hostess to reap the benefits of being a public company without having to navigate a tough market for IPOs. And in the months since, Hostess’ stock price has trended generally up. Gores Group, in any event, seemed pleased with the deal: In January 2017, the company took a second blank-check company public in the hope of pursuing a similar deal in the future. Other instances of Gores Group’s recent activity involve some brotherly love. Back in 2002, a feature in The Wall Street Journal on Alec and Tom Gores highlighted that the two brothers were at the time bidding for the same business, telecom company Global Crossing. In the years since, though, their firms have become less inclined to compete with one another—and more interested in teaming up. In September 2010, Platinum and Gores Group acquired Alliance Entertainment, a wholesale distributor of music, movies and other media that worked with retail giants like Barnes & Noble and Amazon. The firms exited the business three years later to fellow wholesaler Super D after conducting a pair of add-ons. Tom and Alec next partnered on a deal in June 2016, when they recapitalized Data Blue, a supplier of various IT services for enterprise clients in North America. Once again they pursued inorganic growth, as Data Blue added on cloud specialists LPS Integration and Williams & Garcia last year. * * * Despite all those buyouts for companies in the IT, media and plastics industries, it’s possible that Tom Gores and Platinum’s best investment this decade involves sneakers and hoops. In 2011, Tom paid a reported $325 million to take a 51% stake in the Detroit Pistons franchise, with Platinum’s second flagship fund buying the other 49%. Four years later, Gores bought out the stake owned by his firm to take 100% ownership. At the time of the original 2011 purchase, an industry source described it as a “shocking” bargain to business publication Crain’s. Several years later, it only looks better: Forbes’ latest estimate pegs the Pistons’ enterprise value at $1.1 billion. And there are other, indirect benefits. Like the fact that the Platinum Equity logo now occupies a prominent place on the Pistons’ home floor, the firm name written in script on either side of midcourt— the kind of prime brand-building real estate most private equity firms could only dream about. It’s the sort of thing that would make an older brother proud. Even, perhaps, if that older brother is also a part-time rival. Year closed Size Predecessor size Step-up% Thoma Bravo Fund X1 2014 $3.65B $1.25B 287% Vista Equity Partners Fund IV 2012 $3.5B $1.3B 269% BDT Capital Partners II 2016 $6.2B $3B 207% Clearlake Capital Partners II 2018 $3.6B $1.4B 157% Marlin Equity Partners IV 2013 $1.6B $600M 146% Genstar Capital Partners VII 2017 $4B $2.1B 90% Clayton, Dubilier & Rice Fund X 2017 $10B $6.4B 56% Source: PitchBook Platinum's got company: Other notable recent US buyout fund step-ups 60 PitchBook Private Market PlayBook 2Q 2018 Copyright © 2018 Deloitte Development LLC. All rights reserved. Awaken your portfolio Acceptable performance can make it seem like potential is being achieved. But look again. Small adjustments in effi ciency, leadership development, or how capital is used can provide a jolt. With services from audit to consulting, Deloitte can advise private equity investors on such issues across their portfolios, and help open their eyes to what true potential might be. See our services for private equity investors and portfolio companies at deloitte.com/us/privateequity. 12 PitchBook Private Market PlayBook 2Q 2018 Barbarians left behind: How predictive analytics are upgrading PE's playbook By Alex Lykken Imagine you’re a private equity investor. You focus on the US middle market, with a specialty in food-related sectors. Your investment team finds a possible target, a trendy ice-cream maker based in California. A big hit with millennials, the brand has a cult-like following in San Francisco and Los Angeles. The company has already tried to expand, with varying results at new retail locations. Restaurant and grocery store sales, however, were up double digits the past three quarters but disguised by low in-store revenues. It turned out that demographics helped explained the discrepancy; younger customers were behind stagnating in-store sales while older customers were fueling grocery sales. To optimize overall growth, the company needed to account for both trends, and reallocate its resources accordingly. Armed with this insight into consumer behavior, your firm can bid competitively even as others question your team’s valuation. What does this have to do with technology? Not much on the surface—tech poses no immediate threat to the ice cream industry. But technology is playing an increasingly important role when it comes to evaluating a company’s growth potential, and it is quickly changing the nature of private equity due diligence. This is particularly true as it pertains to the use of predictive analytics, which, in PE context, commonly boils down to analyzing how specific clients or users interact with a target company’s products or services. Combining high doses of leverage with cost-cuts is no longer a reliable playbook, and focusing on efficiency measures in a sector like retail, for example, can be like catching a falling knife. That’s where harnessing data and technology comes in. “Where we’ve seen a lot of improvement with private equity- backed companies comes back to reporting capabilities,” says Chris Stafford, senior manager in West Monroe Partners’ Mergers & Acquisitions practice. Private equity owners are expecting to see value coming from those efforts quickly, he added, in as little as six months. More broadly, PE increasingly emphasizes knowledge sharing among portfolio company leaders with regard to technology capabilities. “We’ve seen private equity mature on the operating side,” Stafford said. “CIOs are becoming more aware of what their portfolios need within a certain market. Investors and advisors are hosting more conferences where they can share those ideas. And beyond knowledge sharing, we’re seeing more centralized services being developed within PE firms. In addition, investors and CIOs are hiring specialists to run portfolio diagnostics and provide recommendations to their CTOs to identify any gaps or opportunities to drive revenue growth.” In some cases, leveraging technology has allowed PE sponsors to better identify add-on targets earlier in the process, and many add-ons today are being negotiated ahead of the platform acquisition itself. In other cases, it’s more about getting answers to more insightful questions, like which customers buy more or more often, and which customers are less active? Which clients or client-types come with higher margins, and which are costlier to serve? Perhaps most important, how are company resources being allocated to those specific products, services or clients? This line of thinking isn’t quite the same as identifying a factory to close or a business line to shut down. Those were blunt instruments that worked effectively in the past, when those situations were more common. But PE has been active for almost 40 years, and after such a long and profitable run, the emphasis on the turnaround play is losing ground to expansion efforts. Opportunities today are less obvious in a crowded market and more likely to hinge on boosting specific revenues or margins by as little as 10%. That might not seem like much, but knowing that certain resources can be allocated differently can make the difference between bidding confidently for a target versus passing altogether. Even as buyout multiples won’t always be this high and auctions this competitive, predictive analytics are likely here to stay. That would be a good thing for an industry looking to upgrade its image while uncovering even more opportunities in the years ahead. By Garrett James Black 14 PitchBook Private Market PlayBook 2Q 2018 15 PitchBook Private Market PlayBook 2Q 2018 The evolution of liquidity Shifting exit strategies for private market investors continued > Liquidity is the lifeblood of financial markets. For players in private markets, it is perhaps even more so, and yet is much more complicated to achieve. Illiquidity is a hallmark of alternative investments. But it is not just the relative infrequency of liquidity for private funds that compli- cates matters; rather, even the method of achieving liquidity can be difficult, as there have typically been only so many options for managers to exit holdings. As a result, predicting liquidity trends is complicated, especially considering the protracted lifecycles of private funds. Over the past several years, however, a handful of key trends have emerged amid the general liquidity landscape that suggest private markets players of all types are opening their minds to new ways of realizing value from their investments. 17 PitchBook Private Market PlayBook 2Q 2018 16 PitchBook Private Market PlayBook 2Q 2018 These key shifts represent clear signposts of how the current liquidity market is gradually evolving. Not all types of liquidity are equal; the incentives for and routes to liquidity differ for each type of investor. Therefore, taking a snapshot of the current state of liquidity evolution requires considering those signposts from three perspectives: the LP’s, the GP’s, and the company’s. A quick primer In the wake of the financial crisis, it took fund managers some time, but eventually they embarked upon a period of massive distributions to their investors, finally realizing the largesse dispensed in the pre- crisis buyout boom era—private equity funds alone distributed well over $300 billion per year between 2013 and 2016. The bull market in financial assets that got well underway in the early 2010s contributed to a spree of M&A as well as initial public offerings (IPOs). But every bull market spawns its own particular issues, and this latest was no different. PE funds sold off their most-valued assets to corporate acquirers hungry for acquisitive growth; venture investors took their hottest software platforms public; and both kept on investing from larger and larger funds, per their mandates, aided by their recent success. Assets became pricier. Competition stiffened. Liquidity became an even more important consideration, relatively speaking; a recent survey of LPs by 17Capital revealed 60% of LPs are dissatisfied with the pace of liquidity from 2007-2009 vintage funds, for example. Such a sentiment is highly reflective of the impact of cyclical factors, of which two categories primarily affect private markets: macroeconomic and structural, with secular also often playing a significant role. The macroeconomic is straightforward: Since 2016, there has been an oft-challenged narrative of global synchronous growth that, depending on which factors are considered, could be weakening or persisting. Recalling 2007 and 2008, many investors are fearful of missing out on potentially unprecedented rallies in financial markets that could mark their assets even higher, as well as potential collapses if they hold on for too long. Although 2017 marked the fourth consecutive year of at least $2.9 trillion in M&A value across North America and Europe, volume has ceased to increase, either trending downward or at best persisting. Enter the structural factors: Assets in the private market are inherently illiquid. The trick for investors concerned about liquidity is either creating or finding a market to clear their assets with the participation of all stakeholders. PE and VC managers have traditionally exited their holdings via three main routes: M&A or trade sales, IPOs and buyouts by financial sponsors. The key differing features of each to emphasize from the perspective of private markets investors are speed, scale and time. IPOs have trended downward in volume among both PE and VC firms, likely due to two secular factors: the gradual disappearance of small-cap companies on public indices as markets have inexorably marched upward and mega-companies have grown via consolidation; and better alternatives for additional funding or liquidity events in private markets in general. But to reiterate, not all liquidity events are equal. Different investors hold different perspectives, and each major category of player in the private markets has tinkered with their approach to liquidity. 1. The limited partner perspective: Secondary markets as portfolio management A stake in a fund is a claim to the fund’s assets. Liquidity of any stake is simply a matter of finding a market and settling the sale to the satisfaction of all stakeholders. Consequently, it is natural that stakes in PE and VC funds themselves would eventually enter their own marketplace and become bought or sold by LPs. Whatever the motivation, the global secondaries market is growing—the first three quarters of 2017 alone saw over $34 billion raised in such strategies. More recently, New Enterprise Associates made headlines for its plan to sell roughly $1 billion worth of stakes in around 20 startups to a new vehicle, which would then manage those ongoing investments. That last attribute is a departure from the norm but only further emphasizes how such secondary vehicles and markets have become more common. Looking forward, such arrangements are likely to become more popular among a coterie of firms, as only certain large firms like NEA will possess both the means and the incentives. It is best to view this increased usage of secondaries from a portfolio management perspective. For example, it’s difficult enough to craft a compelling investment thesis and find the right portfolio companies, so trying to align incentives by assembling exposure to certain GPs’ portfolios can be much more complicated. However, with the burgeoning popularity of the secondaries market, LPs now have an additional tool with which to manage exposure to certain funds, particularly within VC— hence the NEA plan, which would provide liquidity for LPs clamoring for returns while offering stakes to those who desire exposure in more mature tech companies. It should be noted that different fund types currently trade at different discounts to NAV, with buyout vehicles trading flat and VC pools at a discount, down to 80 cents on the dollar in some cases. Such pricing is tied more to the relative risk profiles of funds, hence the disparity in discounts. Those ranges of discounts also evidence the maturation of the market; according to recent PitchBook research, secondary fund stakes typically sold at a 20% discount just a few years ago, when their sale was more stigmatized as a last- ditch effort for distressed sellers. As the market has matured and new buyers have emerged, pricing has risen significantly. This is perhaps the most momentous of the signposts of evolution. LP liquidity concerns have ebbed and flowed, as they always will, but rendering liquidity options more efficient by using secondary markets will not only aid in price discovery but also, again, overall portfolio management, from an LP’s perspective. That could make private funds even more alluring to LPs, helping mute typical concerns around illiquidity and access. In short, this trend retains some of the most substantial, potential implications for players in private markets on the whole. 2. The general partner/owner perspective: Hustle & cash flow The GP perspective can be viewed as analogous to that of a company founder or owners of significant equity, in some ways. Through this lens, which emphasizes direct ownership, there are two primary trends of innovation: the sale of GP stakes in management companies and the maturation of secondary transactions, as well as secondary sales on private exchanges. While GPs are typically assessed through the funds they manage, there is also an underlying 0 5 10 15 20 25 30 35 40 $0 $5,000 $10,000 $15,000 $20,000 $25,000 $30,000 $35,000 $40,000 Capital raised ($M) Fund count * Global LP secondary fundraising Source: PitchBook *As of October 10, 2017 19 PitchBook Private Market PlayBook 2Q 2018 18 PitchBook Private Market PlayBook 2Q 2018 management company that oversees the investment funds. In its simplest iteration, the sale of minority stakes generates cash to redeem shares in the management company held by founders, many of whom are at or nearing retirement age; such cash can be used in several additional ways, including launching new strategies and helping junior professionals fulfill their obligation to commit capital alongside LPs to funds they manage. This strategy remains fairly niche, with only the largest, most experienced firms typically embracing the formation of new GP stake-targeted vehicles, such as Goldman Sachs. But, however niche it may appear for now, it does represent yet another incarnation of liquidity options for direct owners of equity in firms themselves. And it is growing in popularity, with the roster of firms that sold stakes expanding to include TPG, Silver Lake, Vista Equity Partners and more. However, it’s not just owners of shares in funds that are desirous of additional liquidity options these days; direct equity owners in some of the most prominent private companies that have emerged in the past decade are increasingly in need of alternative liquidity options as well. Exemplified most notoriously by the unicorn phenomenon, unprecedented capital inflows into mature companies that have elected to grow privately have led to early employees and investors alike requiring liquidity prior to later investors. Accordingly, private exchanges such as those operated by SharesPost or Nasdaq Private Market have evolved to accommodate those who wish to buy or sell exclusive interests to meet their individual needs. Growth has been significant, with Nasdaq Private Market reporting $3.2 billion in private secondary transactions in 2017, a 3x increase from 2016. Secondary sales can achieve a similar outcome while also qualifying as an additional fundraising round. Uber’s recent secondary sale is perhaps the best example of such a deal, with some early employees and investors being able to redeem part of their ownership as SoftBank plied Uber with additional capital. 3. The transactional perspective: Secondhand news Secondary buyouts, buyouts of VC portfolio companies Secondary buyouts (SBOs) have become more popular recently, accounting for half of all PE- backed exits in the US in 2017—the highest level we’ve seen. There are a variety of factors at play here. Record levels of dry powder (unspent capital) have left PE funds with massive sums of capital to deploy. Paired with favorable lending terms, financial sponsors have been able to bid more aggressively to win deals against strategic buyers. PE funds are also facing a particularly competitive dealmaking environment, where quality targets are fewer and deal multiples are sky-high. Pressured by LPs to invest their high levels of capital and facing difficulties in sourcing original, proprietary targets, sponsors have increasingly turned to SBOs. Sellers, on the other hand—who have traditionally preferred selling to strategic buyers—have been happy to offload their holdings at accommodative prices, especially at the prompting of aging inventory needing to be off the books, so to speak. But these deals aren’t last-ditch efforts. Large funds often make a case for purchasing the portfolio companies of smaller firms simply because they can provide better scale than the current owners. On the other hand, large generalist firms may sell to smaller niche firms that have the sector-dedicated resources and growth strategies that can take the portfolio company to the next level. While these transactions can cause potential conflict for LPs who may be exposed to both the selling and buying fund, as long as buyers can continue to deploy effective value creation strategies and sellers can secure the prices and multiples they are content with, all parties can be satisfied. It’s not just buyout GPs that can exit via a sale to a fellow financial sponsor, but also VC fund managers. Much has changed on this front as well recently. 2017 saw a record 20% of exits via buyout relative to all other major types of VC sales, nearly double the levels of the several years prior. This further illustrates how exit strategies are evolving. Much like PE firms turning increasingly to their competitors to sell, VC firms who have seen the IPO option narrow have found diverse exit routes as well. Alternative routes to public markets: Spotify & SPACs Due to lengthening exit timelines, investors are finding more creative ways to achieve liquidity through the public markets. Spotify’s direct listing and the increasing popularity of special purpose acquisition companies (SPACs) represent prime examples of this evolution. Rather than undergo a traditional IPO process, Spotify elected to simply list on public exchanges. Such a novel approach led to some head-scratching, as some feared excessive volatility in share price could occur without underwriting support or having a prebuilt book of demand. The twist is that such a change from typical price discovery processes and potential volatility was worth it to Spotify, as all it really sought was liquidity and adherence to its founders’ principles of transparency and equality. Mitigating swings in share prices by ramping up private secondary markets trading prior to the listing, Spotify enjoyed an ostensibly cheaper way of going public. But such a novel form of price discovery and embrace of potential volatility is not necessarily to the liking of all, especially as Spotify had to put in a lot of time and work to pull it off, potentially offsetting IPO commission expenses with internal efforts. More critically, not every company enjoys Spotify’s status as the sole significant independent contender in the cutthroat music streaming world, as monoliths Amazon, Google and Apple loom in the offing. So while Spotify’s direct listing may not change the traditional IPO process dramatically right away, it does illustrate how other unicorns can find creative avenues to go public, with modifications to typical processes that can suit each to their preferences. By design, SPACs are intended to purchase one company for one purpose—offer exposure to that particular business for investors in the SPAC. Of course the acquisition of a controlling stake in a private company by a SPAC is also a method to take the company public. Investors want access to companies like Airbnb and Pinterest, which traditionally would have likely been public by now but have been able to scale with massive amounts of capital in the private markets. From a transactional perspective on liquidity, the salient point is reaching an agreement that can satisfy all participants. Accordingly, more bespoke SPACs targeting specific unicorns are likely to ensue. 4. Signposts in a shifting land Confronted with a challenging, competitive marketplace, as of late, GPs, LPs and even employees have increasingly employed creative methods to get what they want—their money back and then some. Clear signs of change have emerged from the shifting landscape, hinting at which seller preferences are taking priority and the top choices of owners of equity in not only private companies but also investment firms themselves. The upshot is that, promisingly enough, all the ways and means enumerated here aren’t likely to be the end-all, be-all of how fund managers get capital back to their investors and employees finally cash out of the companies they’ve spent years building. Rather, they represent a current snapshot of how the entirety of private markets players are opening their minds to new ways of buying and selling pieces of value in multiple markets, trying to find the right matches for the right assets. The signposts of this snapshot are clear, and yet, it is always worth bearing in mind that the evolution of liquidity in private markets all around them will continue, slowly and gradually. 21 PitchBook Private Market PlayBook 2Q 2018 20 PitchBook Private Market PlayBook 2Q 2018 2018 has set the economy on a new course. Recent legislative changes lowered corporate taxes; tensions among trade partners have stirred into the possibility of a trade war; and interest rates have risen. These shifts present challenges throughout the financial Hot middle market lending environment comes with competition and new challenges impact of tax change. Since then, much of the activity has been driven by repricings, refinancings, and add-on acquisitions. We expect strong M&A activity through the remainder of the year. Senior stretch and unitranche are the favored structures utilized by sponsors given the ease of execution for the original platform and for future acquisitions to support the growth strategy. First- lien/second lien structures provide the most leverage for transactions with higher purchase multiples. However, given the rise in LIBOR rates, fixed-rate mezzanine debt is becoming more cost competitive relative to second lien. Before we get granular, what’s your opinion of where we are at in the credit cycle and how that will impact middle market lending? What about broader economic trends? 2018 has been a strong year to date, and we expect positive performance through the course of the year. It seems everyone is on pins and needles waiting for a downturn based on where we are in the current credit cycle along with noise around inflation, interest rates, rising trade tariffs, and a potential trade war. You cannot mitigate an economic correction, however, you can back the right company, management team and sponsor, particularly those that have experience working through (and emerging from) an economic downturn. The senior professionals at Twin Brook have been focused on the middle market for the last 20+ years and have been through multiple cycles. We are not afraid of another downturn because of that experience. Unlike many new entrant middle market firms, we have invested in staff and resources that follow a “credit first” mentality in both a down market as well as a bull market. We are committed to a long-term strategy. We strongly believe that the lower end of the market is in a much better position as it relates to the basic protections that exist in our credit agreements, which makes us far more resilient in the face of a market correction. Given the level of competition in the current environment, particularly with newer entrants into private debt, what do you think will help firms achieve differentiation? The reality is that most of the new money we see coming into the middle market is directed to the upper end of the market. Why? This is where more syndicated transactions occur that require participants who are happy to Jessica joined Twin Brook Capital Partners in 2015 and is a Director on the Capital Markets team. She is responsible for structuring, underwriting, documenting and syndicating leveraged finance
Private equity and, to an extent, venture capital can be seen as relatively stagnant industries, utilizing core investing strategies that haven’t changed much in decades. But these industries have actually evolved dramatically over the last few years, not just from the perspective of overall market trends but from that of investors. Of course, by “investors” we’re referring not only to the general partners (GPs) that make the deals but also to the limited partners (LPs) that fund the GPs, and even the employees who invest years of their life to help grow companies.
Tech Investment and Growth Advisory for Series A in the UK, operating in £150k to £5m investment market, working with #SaaS #FinTech #HealthTech #MarketPlaces and #PropTech companies.