The hesitant IPO market

We explore the effects of the current macroeconomic environment on the IPO market.

Key points

• While many private companies have a desire to go public, there is an overall hesitancy to be first to the market.
• Private companies that have raised large amounts of cash over the last several years are waiting for market conditions to improve before going public.
• The future direction of IPO activity could lead to differentiated opportunities for public-market investors.

Public markets are not the only place where growth valuations have taken a hit in 2022. I spoke to Thomas Karthaus of Newton’s private markets team about the impact of the macroeconomic climate on late-stage private companies, the pipeline for initial public offerings (IPOs), and more. As a facet of Newton’s multi-dimensional research approach, the investigative research team (of which I’m a member) seeks to unearth differentiated and unique perspectives, both inside and outside of the firm, to complement traditional investment analysis. 

From your experience meeting with private companies, how are they thinking about the prospect of an IPO right now?

Broadly speaking, they are all hesitant to IPO. We met one of our portfolio companies recently and their comment was that “we’re not going to be the ones to open the market.” And that is essentially what we are hearing from just about every company we meet. They all have a desire to go public, but none of them want to be the first one, or the one to open the market.

A Nasdaq spokeswoman recently said there are roughly 300 companies sitting on the sidelines waiting to IPO. These are companies that have spoken with Nasdaq, so they know they’re just out there waiting.

Interestingly, Instacart is rumored to be still targeting an IPO before the end of this year. That’s going to be a really interesting one to watch, because it is likely to dictate what the IPO schedule looks like for a while after that. If it goes well, it could potentially open the floodgates with those 300 companies on the sidelines rushing to IPO. We know there are a lot of investors who want liquidity and do not want to miss the next window. And if it goes poorly, they could all be vindicated in their decisions to hold off their IPOs. They could continue to wait, and the IPO market could be dead for another six to 12 months after that. So, all eyes on Instacart at the moment. It does feel like they’re going to be the ones who are brave enough to try to IPO in this current environment.

Why the hesitation?

I think there are a couple of reasons for the hesitation. One, we just have no idea if public market investors are going to be receptive to new IPOs. And what that means is that, first, they don’t know how much capital they’ll be able to raise, or, secondly, at what valuation.

And so, this kind of ties into the other reason. Many of these companies, given the environment that we’ve just come out of, have raised a lot of capital at very high valuations. We’ve got this situation where they’re all worried about coming out at what would effectively be ‘down rounds’ (selling at lower prices than previously). Their investors who participated in their most recent rounds would be taking maybe pretty significant haircuts to the prices of those rounds. And so, they are in situations where, if they do not have to go public, they are really hesitant to do that. And they’re all effectively waiting to see if the market comes back. And many of them, because they were able to raise such large cash amounts over the prior several years, don’t have to come public right away. They have a little bit more flexibility than they might have in other environments.

If they don’t need the cash and they don’t have to come public, they’re going to wait until it’s a stronger environment in which they believe they can have a better exit opportunity for their recent investors.

Their early investors should make out quite well, whether they come out at the last valuation or a 40 to 50% reduction to that last valuation because they’ve been in for so long. It’s the later investors that could get hit particularly hard if they exit at lower valuations.

What does this hesitation say about the state of the public markets?

To be honest, I’m not sure which direction the cause and effect flows. I think it is more the private markets taking their cue from the public markets, rather than the other way around.

Now there are some implications for public-market investors. One is that there are lots of funds out there that like to invest in really interesting growth companies via their IPOs. If we have a dearth of IPOs in the next year, that is a dearth of new opportunities for some of these growth managers to invest in.

The flip side to that, however, is that the longer valuations in public markets stay down, the more likely it is that the private-market companies will come to accept that we are in a new valuation regime.

And as that happens, we could see an increase in IPOs. We could also see opportunities for public companies to start acquiring some of these private companies, and the potential for a merger and acquisition wave. It could be really interesting for many of the public companies to use their currency to acquire many of these private companies that are at the moment foregoing IPOs.

Authors

Jack Encarnacao

Research analyst, investigative, Specialist Research team