Opportunities in Private Equity

Marcus New, CEO and Founder of InvestX, shares how the bear market is impacting private equity, and why he sees the next six to 12 months as a “compelling time” to make money in private equity. Marcus also talks about the biggest trends he is seeing in the space. 

How are the private markets performing this year? 

As the market continues to be extremely volatile and a recession is approaching, private equity deals have slowed down. Deal value in the first half of 2022 totaled $529 billion, a healthy figure by historical standards, but we’re expecting activity to slow for the rest of the year. While strategic acquisitions dominated exit activity in Q2 and Q3, sponsor-to-sponsor exits slowed and IPOs were non-existent. 

It’s also important to note less than ten years ago, the statistic was that companies were staying private for 4-6 years and there were fewer than 100 private companies with a billion-dollar valuation or more. 

Today, there are more than 1,170 companies that have a billion-dollar valuation and on average have been private for 10-13 years. With that in mind, it’s still a great time to be active in the private equity space.

How is the bear market impacting private equity? What do you anticipate for the rest of the year and next year? 

The current problem is similar to the pandemic period: there are limited or no bids in the private market. Some traditional investors who bought a lot in the private markets have left the market as the public bear markets significantly impacted their portfolios. Meanwhile, crossover funds have trickled to a stop on new investments and some of the largest private investors - Tiger Global and SoftBank - have suffered significant losses in their hedge funds. 

At InvestX, we believe that over the next six to 12 months, it will be another one of these compelling times to make money in private equity. We will see opportunities similar to those that arose during the market downturn caused by the pandemic, where increased pressure on costs and earnings estimates causes valuations to be lowered.

As is always the case, timing is everything. Timing market downturns precisely is never easy. That said, we have some advantages in the private markets space as we can leverage insights from the public markets, especially when it comes to public company disclosures and information on where stocks and bonds are traded. The valuation moves in the private market tend to lag, which means we have a little bit more time to adjust to the downturn.

They also tend to stay at the bottom for longer, rather than bouncing right back up as market sentiment changes. With that, bear markets create opportunities as we usually see many distressed sellers with broad assets to sell-off. This includes hedge funds, mutual funds and cross-over investors on the sidelines, resulting in a strong imbalance of sellers to buyers.

How does it differ from public markets’ performance this year?

Private markets have a strong correlation with the public markets but have some significant differences. Since the time horizon of a private security is usually multi-year and venture-backed issuers raise money on average every 20 months, investors do not have the same motivation to sell in illiquid markets and the issuers do not have to raise another round of funding, which would in normal bear markets reset the valuation lower in most cases. 

As a result, private companies are able to hold higher valuations through unsettling periods. This in essence gives private companies time to grow into the new valuation reset that has happened in the public markets. Large funds like Fidelity have marked down their private positions in their public funds to strike a reasonable NAV (net asset value), however, private funds do not have the same requirements due to closed end fund structure. 

What are some of the biggest trends you are seeing in the private vs. public markets?  

Private issuers were some of the first companies to cut costs and layoff people. One of the most pressing issues venture-backed issuers face today is extending their balance sheet and how to avoid raising a new round of capital in this market environment. This is one of the reasons they reacted so quickly to cost cutting compared to public company peers. 

If you are an issuer today who is growing less than 50% and has to raise money, you are almost certainly raising at a discount to your last round or giving away significant investor-friendly terms. Issuers are trying to avoid raising money at almost all costs.

We expect to see more venture debt deals being done, convertibles with investor friendly terms, but allow for higher valuations, and creative financing structures vs. the past few years of straight no term preferences at higher and higher valuations.

Secondary liquidity has dried up. With the volatility in the public markets, a recession looming, and fear running through all asset classes, institutional bids in the secondary markets are on the sidelines. As a result, trading volumes have plummeted. Currently we see bid offer spreads over 20%. In addition, because information is asymmetrical in the private markets, many investors are fearful of what the real performance of the issuer is.

There is a misperception that a lot of new cash is being raised by venture firms. VCs raised more money in the first half of 2022 than in the prior period. We believe this is a false flag and that it has slowed. Most VC funds are raised under regulation 506b, which does not allow them to publicize their fundraising until it is complete, which also means many completed their raises in 2021. Many of these funds have also been investing out of their funds prior to the final close so by the time they close, some of the capital is already invested. 

The near-term investing climate is likely to be a test for this generation of private equity and venture firms, most of which saw their fortunes increase in the last decade with higher and higher exit multiples. With valuations resetting in the public markets, high growth private issuers will have a lost year or two. The term “lost years” refers to the time it takes for the issuer to grow into the new valuation reset, lowering investor returns in private funds. Overall, returns over additional years lowers the annual return. 

There are talks that we will enter a recession next year, do you think private equity will outperform the public markets? 

Given the current macroeconomic conditions, inflationary pressures and general uncertainty, we still expect private equity to outperform public markets. There’s a low number of institutional investors active in the market right now, as many of them are dealing with the challenges posed by public securities, presenting a significant opportunity for the secondary market. According to Moonfare’s analysis, deals raised around the global financial crisis from the top-quartile vintages generated a 61% internal rate of return and by contrast, the S&P 500's annual return in 2008 was -38%, proving that private equity tends to be recession-proof. 

For example, we see companies grow mostly when they are still private, which is related to the fact that IPOs happen much later these days. When you look at the growth rates when companies initially IPO, most have a very difficult time sustaining those rates. Given we only see these growth rates in the private sector, we think the private equity market will outperform the public markets.

InvestX is focused on late-stage growth companies in the private markets – why and what do you look for? What should investors know about this space? 

The private market is one of the fastest growing and most coveted asset classes. Considerable wealth has been generated by some of our country’s most dynamic private companies, and in turn for their investors. The growing demand of retail investors’ appetite to access the private markets has pushed regulators to broaden access. As the demand for the private market asset class has increased, many sell-side institutions have not been equipped to meet their clients demands for access to these pre-IPO unicorns. At the same time, navigating the private markets is both highly complex and incredibly opaque, as information on business performance is scarce and non-public. 

With decades of industry expertise in the private market sector, InvestX saw this as an opportunity and we have helped our client’s navigate the complexities of transacting in the private markets by providing the ability to access, invest and trade in late-stage private companies. We are bringing technological innovation to a traditional industry that is ripe for technological disruption,  and providing well-needed solutions to help transform this industry. 

As the securities regulations continue to change in favor of an individual investor, this creates insatiable demand for this asset class. InvestX enables sell-side firms – including broker-dealers, wealth management firms, RIAs, and financial advisors – to provide access to their clients and participate in the massive profits that are generated before a company goes public. InvestX is creating greater access to the growth equity asset class by offering trading technology that brings efficiency, liquidity, and transparency to an antiquated process.    

How is InvestX driving change in the private equity market?

InvestX is democratizing the private equity markets by empowering its clients with access to world-class pre-IPO companies on a state-of-the-art trading platform, InvestX GEM (Growth Equity Marketplace), offering a marketplace, real-time trading technology and insights for investing and trading in private securities.  

Founded on the premise that the private equity asset class should be available to a larger group of investors and not the exclusive domain of the institutional investor, InvestX opens up the private markets to broker dealers and wealth management advisors. Our goal is to bring transparency and trust to an opaque marketplace. InvestX GEM is at the forefront of that opportunity working to connect broker-dealers with access to shares of private billion-dollar technology companies, such as Impossible Foods, Instacart, Varo Bank, Kraken, Epic Games and SoFi, all of which are in InvestX’s portfolio. 

This interview originally appeared in our TradeTalks newsletter. Sign up here to access exclusive market analysis by a new industry expert each week. We also spotlight must-see TradeTalks videos from the past week.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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