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Private Equity Quarterly Q2 2021

Private equity swims toward late-stage venture targets

What do the following companies have in common: Clear, DoubleVerify, LifeStance Health, SoFi and Squarespace? All these companies went public in 2021, either though IPO or SPAC acquisition and received both venture capital investment and private equity financing prior to their public listing.

While tech and life science companies typically receive venture investing, it’s becoming increasingly more common to see private equity funds target venture portfolio companies with growth capital. What’s driving private equity firms to swim upstream to late-stage venture from their traditional buyout strategy? This article assesses the drivers of this trend and finds that the synergy between venture targets and private equity investors will fuel its growth.

Sizing the market

Late-stage venture companies have experienced significant growth and success over the past decade. One indicator is the value of unicorns, a term venture capitalists coined to describe private companies valued at $1 billion or more. As of July 2021, 750 unicorn companies worldwide had a cumulative valuation of about $2.37 trillion, according to CB Insights. Crunchbase data shows that the number of companies added to the unicorns list increased from an average of 16 during 2011–2013 to an average of 170 during 2018–2020. As of May 13, 2021, 166 additional unicorns joined the herd.

Likewise, private equity’s investment in unicorns has ballooned and already measures over $35 billion during the first half of 2021 (see Chart 2). Unicorns in the information technology space received the most private equity dollars in 2020 and the first half of 2021.


Chart 1: Number of new unicorns added

Chart 1 Number of new unicorns added

Source: Crunchbase News. 2021 data is through May 13, 2021.


Chart 2: Private equity investment in unicorns, by sector

Chart 2

Source: Pitchbook Database. Data for 2021 as of June 28, 2021.


Private equity funds’ interest in venture-backed companies isn’t limited to unicorns. In 2020, private equity firms participated in more than 800 venture capital transactions worth a combined $48.3 billion in the United States.

Private equity’s latest push upstream reflects the industry’s ability to evolve strategically in changing investment environments. What started as a small set of leverage buyout (LBO) firms in the 1980s has morphed into a mature industry with a variety of sub-strategies focused on middle-market companies, technology companies, healthcare, secondary investments, ESG factors, distressed companies and more. In fact, some of the well-known LBO shops of the 1980s have recently raised growth funds:

  • Blackstone — In early 2021, it closed its $4.5 billion inaugural growth equity fund targeting opportunities in life sciences. This fundraise followed its 2018 acquisition of Clarus, a global life science firm.
  • KKR — Earlier this year, it closed on a $2.2 billion tech fund, five years after KKR launched its technology growth equity strategy.
  • Bain Capital — In 2019, it raised more than $1 billion for the Bain Capital Tech Opportunities Fund targeting mid-market control buyouts and late-stage growth capital, a strategy that sits between the firm’s buyout and venture businesses.

What’s driving private equity to late-stage venture investing?

While venture investing is generating a steady supply of companies hungry for growth capital, additional factors paint a clearer picture of why private equity has expanded into the venture space. The key drivers include:

1. Potential for higher returns

For private equity investors, late-stage venture-backed companies have the potential to provide better returns than traditional buyout investments. As Chart 3 indicates, the venture/growth investment sub-strategy has generated the highest returns on a 10-year annualized time-weighted basis. The abundance of late-stage capital allows late-stage companies to stay private longer and enables private investors to capture a greater proportion of value generated before they go public. In fact, researchers have shown certain later-stage investors often receive guarantees and other generous terms, compared to other shareholders. Investors in private companies with new, innovative technologies hope to participate in the next-generation winner-takes-all global platforms, such as Facebook, Apple and Google, which grew into trillion-dollar public companies.


Chart 3: 10-year annualized time-weighted returns

10-year annualized time-weighted returns

Source: Hamilton Lane Data via Cobalt, March 2021.


2. Growing opportunity set of investment targets

Rapid advances in new technologies such as the cloud, open source, artificial intelligence and collaboration tools have significantly lowered the cost of creating and scaling companies. In addition to the current private unicorns, late-stage deal flow is expected to remain strong, as evidenced by an increasing number of Series B and C rounds (see Chart 4). Moreover, these opportunities provide private equity investors an insider’s view into new innovations and growth drivers in rapidly changing industries, which can inform private equity investors’ strategic approach to their more mature investments.


Chart 4: Number of Series B and C venture deals

Source: PitchBook Database. Data for 2021 as of July 9, 2021.


3. Private equity brings needed skills and expertise

One advantage to having a private equity investor is the skill sets and resources they bring to late-stage companies. Private equity brings many of the key ingredients: governance, operational expertise, industry and service provider relationships, and deep domain knowledge. These characteristics help accelerate more efficient production and the geographic expansion necessary to scale rapidly. They’re also vital to executing a liquidity event.

4. Buyout investors’ diversification needs

For private equity groups building multi-strategy platforms, offering late-stage investments may help address limited partner investors’ portfolio diversification needs. The addition of late-stage investments with a risk and return profile distinct from buyouts and early-stage venture — as well as the potential to invest in fast-growing, but difficult to access, unicorns — could be especially valuable in helping investors build more diversified and better customized portfolios.

Categorizing late-stage investors and their investment styles

Given the attractiveness of pre-IPO companies, a variety of players have targeted this space. Each brings something different to the company, and these characteristics define four categories.

1. Traditional multistage venture

In the traditional venture capital model, general partners are focused on financing, monitoring and adding value to innovative startups using early- to late-stage investments made by a single flagship fund. Today, many venture capitalists are multistage investors, raising $1 billion–plus growth equity funds as well as smaller funds to seed young startups. By raising larger growth funds, these venture capitalists can double down on successful, later-stage companies to give them more runway to grow and generate more value. A sampling of firms fitting this model includes General Catalyst, Lightspeed Venture Partners, New Enterprise Associates and Sequoia Capital.

2. Growth equity

In addition to private equity firms, such as TPG, Bain Capital and Blackstone, raising growth funds after establishing a traditional buyout model, growth equity firms such as Summit Partners, TA Associates and Insight Partners were founded on this strategy. Like buyout firms, growth equity firms tend to have large (often global) platforms that can bring relevant skills, networks and domain knowledge as well as complementary investment strategies such as private credit.

3. Nontraditional investors

Newer entrants to the pre-IPO space include nontraditional venture financing providers who invest large amounts of capital without adding operational expertise. In Q1 2021, these pure capital providers accounted for 78% of the total venture deal value, or $57 billion, and were a big driver to late-stage megarounds, according to PitchBook. Because public markets offer fewer opportunities to invest in young, fast-growing companies, these investors are increasingly putting capital to work in pre-IPO companies with their potential for higher returns. This group includes hedge funds, mutual funds, sovereign wealth funds and family offices. A few firms in this category that made investments in unicorns this year include ICONIQ, SoftBank and Tiger Global Management.

4. Special-purpose acquisition companies

Special-purpose acquisition companies (SPACs), or “blank-check companies,” represent a newly revived vehicle to enable private companies, including venture-backed late-stage companies, to access the public market. Advertised as easier, cheaper and quicker than IPOs, SPACs have experienced significant growth. In 2020, 248 U.S.-based SPACS raised over $83 billion for potential mergers, and another 366 raised $112 billion just in the first half of 2021. A growing number of private equity firms — such as Apollo Global Management, KKR and Bain Capital — and venture firms — such as General Catalyst, Lux Capital and Altimeter Capital — have also registered SPACs. SPACs can play a complementary role to late-stage investors, as SPAC acquisitions can provide a faster exit strategy for portfolio companies.


Implications and insights

Many private equity firms have made financing pre-IPO and pre-acquisition companies a key part of their overall strategy. What are some of the bigger likely implications to this trend?

  • Startup founders and entrepreneurs — Plentiful capital from a varied and growing number of providers gives founders competing options for late-stage financing. As a result, the balance of power has shifted away from investors to founders and entrepreneurs.
  • Investors — Likewise, investors must increasingly differentiate themselves to participate in late-stage deals with quality founders. Private equity’s skill sets, networks and relationships (including existing portfolio companies), as well as its deep experience taking companies public, put it in a strong position to become a long-term partner with founders.
  • Technology and innovation — The abundance of capital across the venture life cycle and the lower costs of starting a company, compared to previous decades, award entrepreneurs more freedom to experiment with transforming ideas into potentially promising products and services. This environment is also fostering a growing pipeline of late-stage investment opportunities to the benefit of private equity and other investors.
  • Public markets — The decline in the number of U.S. publicly listed companies hasn’t dampened the demand for new and diversified stock investments. However, the time between first investment and IPO can be long — almost seven years in 2019 — and a strong public offering requires additional capital to prepare the company for going public. Private equity groups provide this needed capital as well as operational expertise to transform late-stage venture-backed investments into stronger public companies.

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The content of this publication is for information purposes only and should not be considered as legal, financial, accounting or tax advice, nor as an investment recommendation or an endorsement of any investment fund. First Republic Bank makes no representations, warranties or other guarantees of any kind as to the accuracy, completeness or timeliness of the information provided in this publication. You should consult with your own professional advisors to fully understand and evaluate the information provided in this publication before making any decision that could affect the legal or financial health of you or your business.

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