Once upon a time, if a fast-growing company wanted to fuel its growth, it had to go public. Stock exchanges were where the money was, and where chief executives had to go to sell their story. Now, whether it is Masayoshi Son committing $4bn in a 12 minute meeting, or a team of grizzled venture capitalists committing $4m after extensive due diligence, many fast growing tech-related firms would rather tap sources of private capital rather than rush into listing.
“With the change in the yield environment, investors are allocating larger pockets of capital to alternative investments in general, and direct investment has been one of the major alternatives,” says Isabelle Toledano-Koutsouris, head of private capital markets EMEA at UBS. “As companies stay private for longer the size and complexity of transactions is increasing therefore strategically we had to respond to that need.”
Where there’s money, investment banks tend to follow, and none faster than Goldman Sachs, which has a dominant spot in tech initial public offerings to defend, and a desire to find new and fertile corners of capital raising.
The firm set up an alternative capital solutions unit in 2016, aiming to serve this need. In hindsight, it seems like an obvious step — who better to find potential investors than a global trotting investment bank, facing investors from family offices to giant corporations, sovereign wealth funds and institutional accounts?
Goldman Sachs and others are following some of their better clients into this market — the largest fee payers in investment banking are the big financial sponsors, and the likes of KKR, CVC, Advent and Permira have all established growth capital units in recent years.
“Lots of our more traditional financial sponsors have raised dedicated growth capital funds,” says Mike Marsh, head of EMEA credit financing and global co-head of alternative capital solutions at Goldman in London. “The investment opportunity for the funds is clear but the insight this flow of intelligence brings to a GP can be valuable also.”
Staying private for longer
While the individual capital investments may be small, businesses may prove disruptive to existing portfolio companies — or buy-out targets.
But intermediating the flow of private capital through an investment bank has not necessarily been the norm. Specialist boutiques will help to connect venture money to start-ups, and a big part of early stage investing is originating your own investment opportunities. Successful funds run incubators to make sure they get first bite of the cherry, knowing that there’s a limited and illiquid market connecting companies needing capital with potential growth company investors.
“The specialist venture capital firms come in at an earlier stage than we do, and we can play a complementary role,” says Toledano-Koutsouris. “We might be involved from series ‘B’ or ‘C’ onwards, but companies are staying private for longer. Banks have understood that companies need to be accompanied on this journey, you can’t just show up and pitch for the IPO.”
Fundraising in the early stages of a growth company’s life has historically involved founders themselves tapping family and friends for cash, or managing their own pitching and capital-raising. While a founder or CEO is always going to be involved in a strategic capital raise, they’re unlikely to have the same breadth of investor relationships as the likes of Goldman Sachs.
“Historically we have seen founders using their own network to raise capital, advisers have played a part but it has been less prevalent than in other forms of capital raising,” says Marsh. “We feel that our capital raising platform has not disrupted an existing ecosystem… [rather, it has been more] …accretive and additive to an existing one, offering founders and growing companies access to a broader source of growth equity.”
Other banks have also set up similar units, with the likes of JP Morgan and Morgan Stanley — the other major tech houses — performing the same role. Swiss banks Credit Suisse and UBS come at the opportunity from a slightly different direction, that of wealth management powerhouses which manage lots of entrepreneur cash. Starting with founder relationships, they want to convert those into mandates for capital raising.
It’s a symbiotic dialogue — the ultra-wealthy, investing through family offices, are frequently keen to invest directly in private growth tech opportunities directly, and may want a more hands-on approach than if they seeded a VC fund. They look to their banks to provide this flow of deals.
“For a family office, they can either travel the world themselves looking for the next Uber or Spotify, or they can plug into our flow of opportunities,” says Lyle Schwartz, a senior member of Goldman’s alternative capital solutions unit looking after equity private placements. “I can’t remember a time when there’s been more interest in a new market.”
UBS set up its private capital markets unit this year, run by former corporate DCM head Toledano-Koutsouris, which, unlike the Goldman unit, also seeks to originate and distribute bespoke debt opportunities as well as growth equity and other non-control equity.
“One of the reasons we are an early adopter of this approach is that we are one of the largest global wealth manager in the world,” says Toledano-Koutsouris. “A lot of our clients are entrepreneurs, and we can help them access capital or liquidity before they go to the public market.”
Winning big
The business is light on regulatory capital — it’s largely advisory, and, like an IPO, there’s no hard underwriting — but that doesn’t mean it’s cheap. The time commitments and the sheer manpower required, for relatively small-sized, non-principal deals mean that it’s not an obvious standalone money spinner.
It is, however, a business where banks can win big — successful fundraising early on can mean a client for decades to come, a lucrative IPO, debt offerings down the road, and a strategic relationship that can bypass beauty parades. “We hope to build strategic relationships with the companies we raise capital for, we are in for the long term,” says Marsh. “A given capital raise is not a single time events for us.”
Further down the road, the business of raising growth capital could morph into a chance to trade it — but this hits the problem that many growth companies want tight control over their shareholder registers, and choose investors for strategic reasons, not just because they offer the most attractive investment terms.
“The strategic angle is important in private financing,” says Toledano-Koutsouris. “Yes, you want to grow your business, but with the right partner. The right investor for expansion in Asia might be different from the right investor for expansion in Europe.”
That doesn’t necessarily mean founders or early stage VCs have the right idea about who their partners should be. Working with a bank, rather than originating their own capital, might come with higher fees — but it means a far broader range of investors might have the chance to come in.
“Some companies start with a preconceived notion of the kind of investors they want — perhaps it’s one of the biggest asset managers, perhaps it’s a top flight VC, perhaps it’s a strategic investor they know they want to work with,” says Schwartz. “Part of what we do is turn them on to the diversity of capital that’s available, and sometimes through the exercise these preconceived views change.”
A broader range of investors, and a relaxation of control over the shareholder register might help to create limited liquidity in some private stocks — and that, in turn, means better reference prices, and the chance to lend against private equity placements.
Again, it’s not a new idea — though it tends to hit the headlines only when it goes wrong. WeWork chief executive Adam Neumann, for example, was able to raise a $500m margin loan with JP Morgan, Credit Suisse and UBS, despite there being no transparent ‘market’ price for WeWork stock.
That will have hurt the banks in question, but one rough trade doesn’t mess up the market. Plenty of founders still have their wealth bound up in concentrated privately held equity positions, and want investment bank help to access this money.
Still, WeWork has cast a bit of a shadow over capital raising in private businesses — particularly those touted as disruptive, tech-enabled businesses. While companies can stay private for longer than ever before, there’s usually a public market exit in mind at some point, and a disappointing run of tech unicorn IPOs this year — WeWork never made it out of the gate, but Uber, Lyft, Peloton, and Slack did — has left valuations less rosy than before.
“The valuations you can achieve in private markets have adjusted to the recent situation in the public markets — everything is linked, and you cannot separate them,” says Schwartz. “Private markets had got a little way ahead of public and recent deals have been a reality check. But big picture, we’re near all-time stock market highs and private capital markets remain open for high quality growth companies.”