THE INSTITUTIONALIZATION OF THE PRE-IPO EQUITY MARKET 1
A LONGER ROAD TO THE PUBLIC MARKET... For decades, there has been a well-worn path for innovative and fast-growing companies funded by venture capitalists build the business for a few years, then IPO or sell to a strategic acquirer. In recent years factors such as the costs imposed by Sarbanes- Oxley have caused many companies to choose to step off the beaten path and to stay private longer. For VC-backed companies, the median time to IPO has increased by over 30% since the passage of Sarbanes-Oxley (see Appendix A). And today, at a time when the median market capitalization of VC-backed IPOs in the U.S. markets is ~$650 million, there are currently over 50 VC-backed companies with valuations greater than $1 billion that have chosen to stay private. So the question is: how can these companies that choose to stay private longer obtain financing for growth or provide liquidity to early investors when valuations have advanced so far beyond the investment parameters of most VCs?...REQUIRES A NEW SOURCE OF PRE-IPO CAPITAL Since the beginning of 2010, institutional managers of public equity assets have invested in 358 1 financings for private technology companies before those companies went public. Some of these institutional investors have even set up special vehicles specifically targeted at the pre-ipo asset class. GROWTH OF PRE-IPO INVESTMENTS BY PUBLIC MARKET INVESTORS 26% CAGR YTD 1 2010 2011 2012 2013 2014 Annualized Source: Pitchbook This trend reflects a realization by institutional investors that in order to access the type of outsized growth they once found buying IPOs, they must now be willing to consider purchasing shares 12-24 months before the IPO. 1 Source: Pitchbook, data as of August 31, 2014. 2
INSTITUTIONAL INVESTORS BRING NEEDED BENEFITS... The participation of institutional investors in pre-ipo financings is great for fast-growing issuers that are not yet ready to subject themselves to the added costs and scrutiny of being publicly traded. 1. Better alignment with public market valuations: Institutional investors generally have different returns benchmarks than VCs and may have different insights regarding the likely future market value of late-stage private companies. As a result institutional investors may be comfortable paying a higher pre-ipo value than a VC. In fact, in 2014 year-to-date 3 the median valuation for pre-ipo financing rounds that included public market investors was ~$750 million more than the median market value of a VC-backed IPO! $2,000M VALUATIONS IN FINANCING WITH PUBLIC MARKET INVESTORS $140M FINANCING SIZES WITH PUBLIC MARKET INVESTORS $120M $1,500M $100M $1,000M $80M $60M $500M $40M $20M 2013 2014 2013 2014 Source: Pitchbook Median VC-backed Tech IPO Mean Median 2. Better IPO: By staying private longer, companies can come to the IPO market with a more mature business model, larger scale and more consistent operational performance. In addition, adding well-respected institutional asset managers to the shareholder roster ahead of the IPO can be a positive signal to other public market investors at the IPO. 3. Better performance after the IPO: Institutional asset managers buying shares pre-ipo typically do so in order to build a long-term position, and often add to that position at the IPO and in the aftermarket. As a result, a company raising capital from these institutional asset managers may experience less share price pressure around the expiration of the IPO than if it had raised money from VCs. 3 Through August 31, 2014. 3
...AND THE BENEFITS ARE MUTUAL Twitter s 2013 IPO is widely cited in discussions about the pre- IPO investment opportunity. Examining this high-profile example shows the potentially huge returns available by making the right investments in the private market: a prominent mutual fund made investments in Twitter from 2009 through 2011, accumulating a pre-ipo position representing about 1% of the shares outstanding before the IPO. This position would have cost $120 million at IPO. However, by purchasing pre-ipo, the mutual fund was able to obtain these shares for less than $13 million. At the first filing after the IPO, the mutual fund had a gain of $266 million (~23x its reported original investment) an order of magnitude greater than the return that competing firms would have realized by purchasing shares at the IPO. public in July 2014. In August 2013 a mutual fund purchased $58 million of Mobileye s shares at a price which turned out to be less than one-third of the price at which the company went public one year later. Since the IPO, Mobileye s share price has more than doubled (from $25 to $53 3 ). who purchased shares at the IPO have experienced tremendous appreciation (2x their investment) but the mutual fund that purchased one year ahead of the IPO has seen a 7x appreciation on its initial investment turning $58 million into stock worth over $400 million. PRE-IPO INVESTMENT INVESTMENT AT IPO PRE-IPO INVESTMENT INVESTMENT AT IPO $300M $500M $250M $200M 22.7x 2.3x $400M 7.6x 2.1x $150M $300M $100M $200M $50M $100M Cost Basis Value 12/30/13 Cost Basis Value 12/30/13 Cost Basis Value 9/8/14 Cost Basis Value 9/8/14 Source: Form N-CSR 12/31/13 Source: Form N-Q 3/31/14, MobilEye IPO prospectus 7/31/14 and Bloomberg While this example is probably an outlier in the sheer magnitude of the outperformance generated, it provides a highly visible example of how the most forward thinking mutual fund managers are using pre-ipo investing to create alpha for their funds. These are just two examples, but they illustrate the point: institutional asset managers can use pre-ipo investing as a means of generating a significant competitive edge. Let s take a look at another company that may not be as big of a household name Mobileye N.V. Mobileye provides software for camera-based Advanced Driver Assistance Systems that has the potential to revolutionize the driving experience by enabling autonomous driving and went 3 At September 8 th, 2014. 4
BUT AN EVOLUTION IS NEEDED... So given these potential returns, why aren t more institutional investors participating in the pre-ipo market? The market is dominated by a very small number of investors. In fact, ten investors accounted for nearly two-thirds of the 409 institutional pre-ipo technology investments completed since the beginning of 2010 4 : 30 INSTITUTIONAL INVESTOR CONCENTRATION IN THE PRE-IPO MARKET 25 Average # of Deals 20 15 10 5 Top 10 11-20 21-30 31-40 41-50 51-60 61-65 Source: Pitchbook This dramatic concentration among a handful of investors does not lend itself to long-term stability of the pre-ipo market. We can speculate as to the reasons for the concentration of investors: 1. Network effect: Institutional investors who have been early entrants into the pre-ipo market have the benefit of relationships with VCs and Silicon Valley insiders; and therefore it s only this small handful of the most active institutions investors who are approached about the best new pre-ipo investment opportunities. 2. Resource constraints: Few institutional investors have resources dedicated to proactively finding and conducting due diligence on private company investment opportunities. 3. Lack of visibility: It is difficult for outsiders to determine which institutional investors might have an interest in pre-ipo investing and who would be the right contact point within that institution s organization. 4 Source: Pitchbook 5
...TO COMPLETE THE INSTITUTIONALIZATION OF THE PRE-IPO MARKET Institutional investor participation in the pre-ipo equity market can be broadened significantly but structural changes to the marketplace will be required: Define a network of institutions that pre-ipo companies can approach for financing. At Liquidnet, we know through direct dialogue with our 750 institutional investor Members that there are at least one hundred institutions interested in pre- IPO investing beyond the ten who make up most of today s market. Create efficiencies using technology to facilitate interaction between pre-ipo companies and the network of institutional asset managers seeking pre-ipo opportunities. Liquidnet has developed a web-based technology solution that provides this functionality; this solution allows companies to aggregate shares from selling shareholders into institutionally-sized blocks to create a controlled, efficient and repeatable process to provide liquidity to shareholders. Identify or develop a central clearinghouse to curate the opportunities presented to the network, highlighting opportunities that match the investment criteria of each institution (e.g. investment size, company stage of development, other metrics). To serve this clearinghouse function, a firm would need existing relationships across the institutional equity investor landscape and credible equity capital markets and private equity placement capabilities. In addition, the intermediary should be independent, unconflicted and able to utilize technology to create efficiency. There is a new class of equity available to late-stage, high growth pre-ipo investors to access for growth capital or secondary liquidity. Approaching this market in a way that addresses the three issues listed above will accrue benefits to the issuer more competitive pricing, broader institutional investor exposure and awareness ahead of the IPO, and deeper demand and will also lead to a more sustainable market. The time for the Institutionalization of the Pre-IPO Financing Market has arrived, and firms like Liquidnet provide the solution to help pre-ipo equity become a broadly held institutional asset class with a deep and diverse pool of demand. 6
APPENDIX 25 2000-2012 AVG: 9.2 years $1,000M $900M 20 $800M $700M 15 1990-2000 AVG: 7 years $600M $500M 10 $400M $300M 5 $200M $100M 1980 1985 1990 1995 2000 2005 2010 2014 Sarbanes-Oxley Act JOBS Act Source: Initial Public Offerings: Update Statistics. Jay R. Ritter Median age at IPO Median Equity Value at IPO 7
CAPITAL MARKETS TEAM jchandler@liquidnet.com +1 646-674-2036 JAY CHANDLER Jay Chandler has more than 25 years of capital markets experience. Jay spent 21 years in Equity Capital Markets at Merrill Lynch. He served as Head of Global Equity Syndicate his last seven years in the group. Jay then managed Merrill Lynch and Bank of America Merrill Lynch s Americas Research Sales group for five years. He has extensive equity fundraising experience and has worked closely with the world s leading Institutional throughout his career. B.A. degree from Princeton University. jwinkler@liquidnet.com +1 646-660-8145 JOHN WINKLER John Winkler has been an investment banker for over 21 years, including eight years leading Deutsche Bank s private equity placement team, and heading the clean tech and power verticals within Equity Capital Markets. John spent five years at Thomas Weisel Partners focused on pre-ipo equity placements, and five years at Patricof & Co. advising entrepreneurial clients. B.A. from Colgate University, MBA from Columbia University, M.S. in Economics from U.C. Berkeley. John has negotiated dozens of private equity investments for high-growth, technology enabled companies such as Pandora Media, MobiTV, Trilliant Networks, and 2Wire. cknopp@liquidnet.com +1 646-674-2275 CHERYL KNOPP Cheryl Knopp brings more than 17 years of financial services and legal experience, including head of Private Shares, Co-Head of Corporate Strategy and Assistant General Counsel in eight years at Liquidnet. As an attorney, Cheryl acted as issuer s counsel on debt and equity private placements, and public debt and equity offerings. Additionally, Cheryl spent five years at Bloomberg advising on product development, electronic trading and joint ventures. B.S. in Economics from Cornell University and a J.D. (magna cum laude) from Brooklyn Law School. capitalmarkets@liquidnet.com +1 646-674-2126 @Liquidnet LIQUIDNET.COM NEW YORK LONDON HONG KONG SINGAPORE SYDNEY TOKYO TORONTO ON A DIFFERENT SCALE 2014 LIQUIDNET, INC. MEMBER OF FINRA/SIPC.