The Decline in IPOs and the Private Equity Market
In their piece, “The Evolution of the Private Equity Market and the Decline in IPOs,” Michael Ewens and Joan Farre-Mensa discuss the decline in the number of initial public offerings in the United States in recent years and how it has impacted the ability of startups to finance. The authors focus on venture-backed startups. Interestingly, the paper notes that the percentage of M&A exits has remained fairly constant since the early 1990s. Many commentators in the popular press have suggested that the number of M&A exits had increased, therefore negatively affecting the number of U.S. IPOs. Prior to 1997, approximately 87% of startups with over 200 employees went public and of those with over $40 million in sales 67% undertook IPOs. Since 2000, the fractions have declined to 29% and 30% respectively. Private capital has filled the breach and as a result the decline in the number of IPOs has not negatively affected the ability of companies to raise capital. In part, the authors attribute the change to a reduction in the costs associated with remaining a private company. The authors also discuss changes in the private markets. For example, the paper shows that VCs have changed how they deploy their capital, with a greater percentage of their investments being devoted to late-stage investments (as opposed to earlier stage companies). Non-VC investors have provided a very significant percentage of financing in late-stage rounds. These investors include private equity funds, corporations making minority investments, mutual funds and hedge funds and investment banks.
A blog reader recently shared with us a paper titled “Private Benefits in Public Offerings: Tax Receivable Agreements in IPOs,” written by Gladriel Shobe. The paper considers some of the criticisms of up-C IPOs as a result of the tax receivable agreements put in place in these transactions. For background on up-C IPOs, see our Practice Pointers. The paper notes that in recent years, 5% of IPOs included use of tax receivable agreements (“TRAs”). The author identifies three “generations” of TRAs. The first generation from the early to mid-1990s involved companies that were taking additional steps in connection with their IPOs to create additional tax assets, or new basis. The second generation TRAs appeared in 2007 with a Duff & Phelps IPO. The paper identifies a third generation TRA that came about in 2010. Finally, the paper notes some recent up-C IPOs that have not used TRAs. After analyzing the various types of TRAs and the rationales for their use, the paper considers whether in the case of TRAs in up-C IPOs pre-IPO owners receive benefits that may not be properly valued or understood by IPO participants.
In his paper, “Sunrise, Sunset: An Empirical and Theoretical Assessment of Dual-Class Stock Structures,” author Andrew Winden presents an analysis of initial and sunset dual-stock provisions based on over 100 companies, including pre-2000 and post-2000 structures excluding up-C IPOs. The paper notes that among the sample set there are many different sunset provisions and provides very useful analysis of these. The types of sunset provisions include passage of a specified period of time, dilution of high vote shares or controller ownership of such shares down to a low percentage of the aggregate number of outstanding shares, a reduction in the number of high vote shares or the number of high vote shares held by the controller as a percentage of the controller’s original ownership, death or incapacity of certain control persons or the departure of the founder, or conversion upon transfers of the high vote shares to persons that are not permitted holders. Of course, a significant percentage of companies with dual-class structures, approximately 39% of those that went public after 2000, did not have sunset provisions. The paper then offers an assessment of the utility of each of the particular approaches to implementing a sunset provision.