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Shifting Dynamics in the Public and Private Capital Markets 

Meghan Daniels Axial | November 25, 2019

It’s no secret that the private equity industry has grown rapidly over the past two decades. The number of active buyout, real estate, and credit funds has increased more than five-fold in the past twenty years, from 900 to over 5,500, according to Burgiss data cited in a recent Ernst & Young report, “A New Equilibrium: Private Equity’s Growing Role in Capital Formation and the Critical Implications for Investors.” 

There’s been an increase in value as well as volume. “Net asset values have grown even faster — more than 15-fold, from about US $130 billion in 1998 to roughly US $2 trillion today,” and more growth is expected in coming years, according to the report. 

As the private markets snowball, the public markets seem headed in a different direction. “In 2017, new capital raised from private markets exceeded capital raised in public markets for the first time in the US. It was a development that went largely unnoticed, yet the implications are significant, wide ranging, and ongoing,” notes the report. The number of public companies in the U.S. is down nearly 50% over the past 20 years, according to World Bank data cited in the report, with similar trends apparent in Europe and other markets. While achieving public ownership might once have been the de-facto goal for businesses, that’s no longer necessarily the case, particularly for middle market companies. 

What’s behind these changes? Here are 3 crucial drivers noted in the report. 

1. It’s not just a buyout game anymore.

As the number of PE firms has grown, they’ve also diversified their approaches, vehicles, and investment models — which has expanded the universe of potential targets. Some firms are highly sector-focused while others look to emulate the long-term model of the typical family office. Assets targeting growth capital are growing at more than two times the rate of buyout funds, according to the report, while fundraising for private capital vehicles is also skyrocketing. “Credit funds now have record levels of dry powder — more than US$270b across mezzanine, direct lending, distressed and other private credit strategies,” notes the report. 

2. Management teams don’t want to deal with going public.

Reporting to a private equity firm isn’t necessarily a cakewalk, but being a publicly traded company comes with myriad reporting regulations that can be a turnoff for management teams accustomed to operating autonomously. “Further, for entrepreneurs and management teams, explaining increasingly complex business models to a coterie of sophisticated investors can be far easier than the ritual of road shows and explaining the model to the broader investing public,” notes the report. These sophisticated investors offer companies benefits beyond simply money in the bank — from experienced operating partners on the ground to back-office professional support. 

Technology is another contributing factor. For tech-enabled companies, it may not be necessary to turn to the public markets. “Today’s tech-oriented companies are much more likely to operate with an asset-light model,” and as such are well positioned to scale with smaller amounts of capital from PE or other investors rather than going public, notes the report.  

3. Institutional investors are well aware of PE’s surge.

The majority of institutional investors — two-thirds — are allocated to private equity, with an average allocation of 10%, and nearly half of these LPs (46%) expect to increase their PE allocations, according to Preqin data cited in the report. 

New institutional investors are also looking to get a piece of the pie. While endowments and foundations are already heavily allocated to PE, there’s a glaring opportunity for investors such as pension funds and insurance companies, which hold a combined $8 trillion in U.S. equities, to play a larger role. “A one percent increase in allocations to PE would increase commitments by roughly US $80 billion, a meaningful amount for the industry,” according to the report. 

High-net-worth individuals and family offices — which hold nearly $15 trillion in assets — offer another avenue for growth. Currently, SEC restrictions exclude the majority of these investors from having direct allocation, but these rules may change. “Last year, the U.S. Securities and Exchange Commission (SEC) announced that it was looking for ways to increase the average investor’s access to private market investments, potentially opening up the private markets to a much broader universe of potential investors,” notes the report.

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