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ANALYSIS: Public v. Private Markets—Follow the Money

Nov. 4, 2019, 11:37 AM

It is no secret that the number of U.S. public companies has been on the decline for several years, while the amount of money raised in the private markets has grown significantly. Will this trend continue in 2020? What will we find if we follow the money?

The Public Problem

Throughout his tenure as chairman of the SEC, Jay Clayton has called for more companies to enter into the U.S. public markets. From his first public speech after taking office, the chairman has urged reducing the regulatory compliance costs for newly public companies. The chairman has often said that the costs associated with initial public offerings, along with continuing compliance costs, are the main factors discouraging companies from going public.

Going public offers many benefits, including a more visible company profile, liquidity, and efficient access to capital. It is, however, expensive and burdensome to become a public company. Issuers will generally hire an investment bank, which will cost a fairly standard seven percent underwriting commission. There will be significant costs for extensive legal, accounting and financial professional services. After the offering, the company must engage in periodic reporting and release extensive financial and operational information. Public companies also face takeover risks, activist investor engagements, and potential class action liability for misstatements and omissions.

The Private Option

Private markets are an increasingly attractive and accessible source of capital for many companies. Fewer regulatory hurdles are involved, and private offerings generally require less extensive documentation than registered transactions. These offerings usually involve lower costs and can generally be effected in a significantly shorter time frame than public offerings. Legislation and SEC rulemaking have made it easier to both raise large amounts of money privately and to remain private longer.

Companies must be eligible for an exemption from SEC registration requirements. Exemptions generally involve restrictions on the available investor pool. Most companies employ an investment bank or a broker-dealer to manage and market the transaction. The offerings usually target seasoned investors, who generally invest with a view to taking long-term positions.

A key question around private offerings is the ability to find an interested and suitable investor. That may become more of an issue in 2020, as in many high-profile offerings, investors have overpaid for their participation.

Another issue in private offerings involves investor demands. What are they looking for? Investors often seek an illiquidity premium, as their shares are usually restricted and cannot immediately be freely transferred. Investors may make demands such as a greater percentage of the outstanding stock or seats on the board in order to compensate for illiquidity risks.

The Crystal Ball

Can the SEC and Congress deregulate public offerings back to a place of market primacy in 2020 and beyond? The short answer, simply, is no. Investors are looking for both fewer restrictions and the opportunity for greater growth. As long as there is a large pool of private money available on reasonable terms, companies will look in that direction.

Next year the SEC will likely ease some disclosure requirements. This tinkering around the edges may influence a few companies, but the results will likely not have a significant impact on the public-private balance. Companies are not turning down public access to capital because of quarterly reporting obligations or proxy disclosure rules. They are staying private because of an abundance of readily available private money and a regulatory environment that allows companies to access it for years. There may be a bit of belt-tightening in the private markets after some well-publicized misses, but in 2020 and beyond, it is likely that opportunities for public investment will continue to lag behind the private markets.

Read about other trends our analysts are following as part of our Bloomberg Law 2020 series.