When will capital come back to private equity?

Additionally, we’ve looked back at 50 years of IPOs in the US and found that when issuance volumes have fallen well below the mean, they have typically done so for one to three years before rising again. And 2024 was the third year in this latest period of depressed IPO activity. More anecdotally, we’re also seeing a growing number of reports in the press about companies planning an IPO, which adds to our confidence.

The wildcard in all of this is, obviously, the current US administration’s policy choices with respect to tariffs. The same policy decisions that have weighed on the US public market year to date will likely weigh on new issuance volumes. This runs the risk of delaying IPO exits even further, but, in our opinion, it’s not a matter of if they come back but when.

Adam: Another issue that’s been on the minds of private equity investors is the rise in interest rates. Does this shift change the way private equity investors should think about the opportunity set and prospective returns?

Matt: I think it does for strategies that tend to employ more leverage and therefore have more direct exposure to interest rates — buyout funds, for example. For strategies that lean heavily on leverage, I would expect returns to look quite different going forward. On the other side of the strategy spectrum, you have areas like venture capital and late-stage growth that are focused on tapping into rapid growth in businesses benefitting from technology-led disruption and are less likely to rely on leverage. Put another way, if you're investing in a company that's growing 50% or 100% a year, then it probably matters less to the fundamental returns of the strategy whether interest rates are at 3% or 4% or 5%. (Read more on this topic in our recent article, “No more free lunch: Impact of higher interest rates on private equity.”)

Adam: In your research, you’ve highlighted the tendency for private companies to stay private longer and the impact that has had on the late-stage venture capital space. Can you talk about that trend and how it has shaped the opportunity set?

Matt: More than a decade ago, we observed that companies were staying private longer for a variety of reasons, from the increased regulatory burden on public companies to evidence of the strong post-IPO performance of more mature businesses. As companies stay private longer, they are more likely to go through their hyper-growth phase while they are still in the private market, rather than when they’ve entered the public small-cap space, and they will tend to be larger when they do IPO. We can see the effect of this trend in the declining number of small-cap companies with a market cap below $1 billion (Figure 3).

The result is that late-stage growth — meaning companies that are about one to four years from an exit event and seeking capital to accelerate growth — is a very different opportunity set from traditional venture capital. Companies may tend to be more mature and relatively derisked, for example. This trend may allow for a different return profile from an investment strategy standpoint, with less need for a “swing for the fences” approach where just a couple of the holdings drive results. Managers may be able to take a more balanced approach based on deep research and strong relationships with companies that could be the next generation of public-market winners. The late-stage category also generally doesn't require leverage, as noted earlier.

Adam: Is the health of the IPO market, or of equity markets in general, more important in the late-stage space, given that these are the companies closest to going public?

Matt: IPOs are one avenue for liquidity in the late-stage market, but when IPO activity is below normal, there are others, including secondary sales and M&A. When it comes to returns, I actually think a more important factor is the competitive landscape. Figure 4 illustrates the point: The private market saw a period of irrational exuberance in 2020 and 2021, which pushed the supply of capital in the late-stage market (blue bars) to a level that far outstripped the demand for it (blue line) and sent valuations soaring.

Today, that dynamic has flipped, with demand for capital more than twice the supply as shown in the chart. With less capital chasing each deal in the late-stage market, there are more opportunities to invest at favorable valuations. So yes, the IPO market does matter, but what probably matters more is how much competitive pressure there is to invest in these assets.

Adam: Along with that improvement in valuations, why do you think the private equity market is attractive today?

Matt: One key reason is that the market is only getting bigger, and certainly in the late-stage space. As we show in Figure 5, 87% of US companies with over $100 million of revenue are private companies. That is a dramatic shift over the last 20 years, and I don’t think it will unwind anytime soon. If anything, it will likely accelerate. There are simply more opportunities to pursue outsized returns as private companies go through their hypergrowth phase before going public.