Baillie Gifford’s Tom Wright discusses why more value is being captured by private equity and how the Local Government Pension Scheme can benefit from this.
A profound shift has occurred in capital markets. Private equity investors such as the Local Government Pension Scheme (LGPS) may have to evolve their approach if they are to have enough exposure to the fastest growing, most disruptive, and impactful companies around.
What is this shift? Companies are staying private for longer. Amazon and Google IPO’d after three and six years respectively, but the average age of a company at initial public offering (IPO) has doubled to 11 years, with Baillie Gifford holdings such as SpaceX still private after 20 years, and Epic Games holding out after 32 years.
More regulation and the increased availability of capital in private markets, as well as public market turmoil, are part of the reason for this, meaning fewer entrepreneurs see going public as the coming-of-age moment it once was.
The opportunity is huge. By January 2023, 2,205 private companies were valued at over $500m each, with an aggregate value of $5.2trn — more than double the size of the listed US midcap market, and almost twice that of the FT All Share.
These include many unique companies such as SpaceX, TikTok owner ByteDance, and payments giant Stripe – all owned in Baillie Gifford’s specialist private funds – which remain unlisted despite being valued in the tens or hundreds of billions of dollars.
Positive impact
They also number businesses that are addressing society’s biggest challenges. Regarding ESG, primary LGPS capital can have a direct, positive impact by enabling companies such as green battery manufacturer and recycler Northvolt, synthetic biology business Solugen, and direct carbon capture leader Climeworks to achieve their goals while also making superior returns.
There is a lot of capital chasing deals and no shortage of investors who can write large cheques at premium valuations.
In contrast to public markets, private companies get to handpick their shareholders. So what makes an investor the partner of choice, able to access the most interesting funding rounds at attractive valuations? And how can LGPS allocators identify which managers will be able to do this?
First and foremost, it’s not just about money. There is a lot of capital chasing deals and no shortage of investors who can (and in 2020-21, frequently did) write large cheques at premium valuations.
More important to founders is an investor who can focus on the company’s long-term development, up to IPO of course, but far beyond that.
This is where there is a mismatch with existing VC structures. These have limited seven- to 10-year lives and become forced sellers just as growth may be accelerating. This does not align with the needs of many founders, who are often mission-driven, focusing on multi-decade transformations and not short term valuations.
At this later stage, founders seek trusted partners from within the VC ecosystem of founders, industry leaders, and earlier-stage investors. These investors embrace risk, support innovation, and invest over multiple funding rounds, laying the foundations for future success.
Founders also value a patient voice that encourages other shareholders to think likewise. A longer-term time horizon enables founders to go through multiple funding rounds with no pressure to IPO before they are ready, just because it may suit the liquidity needs of shorter-term investors. Companies can pursue their strategic objectives rather than obsessing over the risk of the inevitable shorter-term missteps.
Private to public
Having a reputation for long-term and patient support of risk-taking innovators helps generate access to a broad spectrum of the most promising deals globally. Baillie Gifford has earned this reputation, having been early backers of Spotify, Alibaba and Affirm, all of which we first owned privately, and continue to hold in size in public portfolios.
This ability to continue to hold and even add capital from other strategies at and post-IPO is particularly attractive because founders do not want a wholesale change of their shareholder base at IPO, as early backers cash out and are replaced by a host of new owners, many with differing motivations and investment horizons.
Having experience with public markets may also be important as founders seek to position their companies for life beyond the private markets. This may involve discussing governance practices such as those expected by LGPS members, and how to retain a culture that will maximise the probability of success after listing. This is a serious “value add” that traditional private equity investors and deal-focused investment banks are less able to deliver.
The LGPS has always provided long-term capital to exceptional businesses, allowing members’ assets to compound in value over time and deliver sustainable, affordable pensions. But a different approach that understands the changing needs of these businesses is now required.
Understanding this, and identifying managers who can access these opportunities, will enable the LGPS to fully participate in the outstanding returns that these most exciting, innovative, disruptive and impactful companies have the potential to deliver.
Tom Wright is a director in Baillie Gifford’s Private Companies Investor Relations team.
