Junior exchanges can play an important role in bridging the gap, helping companies that may be too small for main stock exchanges to access much-needed capital through public markets.
Companies seeking scale can face challenges tapping public markets, but junior exchanges and a changing focus for PE are helping to create new opportunities.
The final stage of the entrepreneurial growth journey is expansion. By this point, the company has proven that its business model is effective and the focus shifts to rapidly scaling up the venture to capitalize on the growth opportunity.
The company will already be profitable in most cases, or at least have free cash flows that can be channeled into investments that will facilitate growth, but these are unlikely to be enough to achieve the pace of expansion that is desired.
At this point, the entrepreneur may decide to seek additional equity funding, either through follow-on VC, PE or through an initial public offering (IPO).
Building private equity in Mexico
Luis Antonio Márquez Heine
CEO, Asociación Mexicana
de Capital Privado A.C.
AMEXCAP is the Mexican Association of Private Capital, a nonprofit organization founded in 2003 that promotes both PE and VC within the market.
"The private finance industry is at a very nascent stage within Mexico today. About 45 firms participate as fund managers within AMEXCAP. Of these, about seven operate as VC, with the rest in PE. It's a very new industry here, which relates to the fact that local investors are very risk averse.
"Right now the Government is the major investor in entrepreneurs, and has set up a number of incubators and accelerators. It remains the overwhelming driver here, given limited private sector participation. This in turn has stalled the market for exits, as it's taking firms much longer than anticipated to get up to a scale that makes them interesting to a bank or PE firm because the sources of funding from Government aren't sufficiently diverse or deep.. We are lobbying for Government to co-invest with VC firms, which could improve the efficiency of their investments, while helping grow local funds.
"More recently, some VC firms from the US have started to look into local universities and incubators to increase their pipelines, so we're seeing more interest from there. But what is totally different here is the absence of any investing into early research or patents, such as new technologies being developed within universities. Instead, the focus is on established companies or laboratories that are already selling something. As such, another item we're lobbying on is for Government to help create a fund of funds with an express aim of supporting earlier stage start-ups, who are not served at the moment."
Since 2005, a higher proportion of PE invested has come from outside the US and rapid-growth economies remain a particular bright spot. Large majorities of surveyed entrepreneurs from these markets say that access to PE for SMEs has improved in the past five years, with only South Africa reporting no change or deterioration.
In many of these countries, there is only limited access to VC, and this means that PE firms are stepping in to fill the funding gap, taking minority stakes to help companies grow by extending their management team, supporting operational improvements and revamping strategy.
PE activity in rapid-growth markets is dominated by China and India, although Brazil has become an increasingly important destination. Many global PE firms, have established a strong presence in rapid-growth markets, where they now compete against an increasingly confident local PE industry.
In developed markets, PE firms continue to find it difficult to raise finance for large leveraged deals, so their focus has shifted both to mid-size and smaller deals and to generating returns through operational improvements. PE backing provides entrepreneurial businesses with more disciplined corporate governance and a more structured institutional framework for running a business. This kind of stability can be an important lever for growing a company at the expansion stage.
Uncertainty in the IPO markets
Initial public offerings play a vital role in helping growing companies access capital and are also crucial for job creation and economic growth.
Since the dot-com bubble burst in 2001, there has been a significant decline in public offerings in the US. In 1996, there were 791 IPOs, but between 2001 and 2008, the average fell to just 157 per year. Since then, the numbers have rebounded slightly, but they still remain below historic norms.
There are numerous factors driving the challenges facing IPO markets in developed markets. The financial crisis has forced many companies to rein in capital-raising plans until they see greater confidence among institutional investors.
Some market participants also blame the poor quality of some recent IPOs, where listings have failed to live up to their promise, leaving investors nursing losses.
China remains the leading center for IPO activity, with capital raised approaching 35% of total investment. This robust activity reflects both strong economic fundamentals and global investor sentiment, with many international institutional investors continuing to increase the allocation of their total portfolio to Chinese assets.
Outside China, there is also a steady deal flow in other Asian markets, including India, Indonesia and Malaysia, although the number and size of deals are much lower than in China. Key factors driving this trend include the privatization of state-owned assets, plans to modernize infrastructure and healthy corporate earnings.
The luxury of going public
Salvatore Ferragamo, the Florence-based luxury goods company, first started to think about going public in 2008. With the collapse of Lehman, and the subsequent financial crisis, it would be three years before the company would realize its vision to become a public company, floating on the Borsa Italiana in Milan in June 2011, in a transaction that was oversubscribed by investors. After 10 months, at the end of April 2012, the share price had increased by some 90% since flotation.
Unlike many other companies that seek to conduct an IPO, Salvatore Ferragamo's primary motivation was not to raise funds for the business (it is well-financed). Rather, the owners wanted to establish a market for the shares for the company, to increase visibility and to attract talent to work there, according to Ernesto Greco, the company's CFO.
The company considered floating on the Hong Kong stock exchange. Valuations were higher, and it has a closer connection to the emerging markets. But management concluded that Milan would be more suitable.
The Hong Kong market was more volatile, and they respected the European stock analysts more. "We also felt that Milan was a better fit for an Italian company with a supplier base that is 100% Italian," says Greco.
Greco believes that the pressure of the markets can help public companies become more disciplined, professional and operate more efficiently. But he warns that the markets can be too short-term oriented, which conflicts with long-term strategic approach.
"The best combination may well be a family-owned public business with a long-term orientation and a management with good operational skills in the sector of business and the experience to communicate with external shareholders," he explains.
Corporate bonds for small businesses
Founder and CEO,
The King of Shaves
When Will King, founder of men's grooming company King of Shaves, wanted to raise money for his business in 2008, he was faced with a problem well known to many entrepreneurs: limited bank interest.
Even though the company had a five-year track record and plenty of intellectual property assets, it had few fixed assets. To overcome this, King came up with the idea of selling retail bonds to some of his customers.
In June 2009, the company launched its "shaving bonds." In return for a £1,000 investment over three years, customers were offered an annual return of 6% and shaving products worth between £30 and £60 each year. The company raised £627,000, far less than the £5m it hoped for, but a pioneering transaction nonetheless.
Since then, several other businesses have followed suit. These bonds tend to be considerably shorter than conventional ones and have to be held to term without any trading, as they are not listed.
Some offer cash returns, while others offer actual goods or a mixture of the two. In general, the sums raised are usually less than £5m, barring a few exceptions. But the absence of a secondary market reduces issuers' legal, advisory and documentation costs, which King estimates at about £100,000.
The role of junior markets
Not every company will be able to make the step from private company to full-fledged member of the main stock market. Junior exchanges can play an important role in bridging the gap, helping companies that may be too small for main stock exchanges to access much-needed capital through public markets.
These junior exchanges, such as AIM in the UK, have been very successful in attracting listings and investors despite a very challenging period in the wake of the dot-com bubble. But not every junior market has been successful.
Although 14 countries in the G20 have already launched junior market exchanges, only a handful have achieved critical mass.
Common problems include a lack of listings, insufficient liquidity and a tendency for the most successful companies on junior markets to migrate to main exchanges, leaving the weaker companies behind.
Secondary exchange for private company stock
Founder and CEO,
For companies looking to scale, while also compensating shareholders and staff for their efforts in growing the business, most look to the public markets. However, an initial public offering also requires various trade-offs, including greater oversight, public disclosure and regulatory requirements.
For firms not yet ready to take that step, SecondMarket aims to provide a bridging option. Launched in 2005, its overall aim is to link institutional investors with new kinds of asset classes. It has since handled more than US$20b in transactions, across six previously illiquid asset classes, from restricted stock through to bankruptcy claims.
But what has captured the most attention has been its ability to serve as a bridge for companies moving from VC backing through to the public markets. Both Facebook and Twitter, among others, have used the platform to allow early shareholders to trade their stock, with about US$1.2b traded so far.
Ultimately, as CEO Barry Silbert explains, the firm aims to redefine the distinction between public and private companies. Whereas some will use the NYSE or LSE to trade stock, others will do so via secondary exchanges.
To get there, SecondMarket is steadily scaling its platform and its pool of registered investors, which now number over 100,000. It is also actively lobbying for certain regulatory changes, such as in how professional investors are defined.
- Entrepreneurs at this stage should open up to international markets as opportunities arise, use junior stock markets as a source of funding and explore PE.
- Government should avoid stifling PE activity and the growth trajectory of entrepreneurs with more regulations and replicate the approach of successful junior markets.
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