The Takeaway: A Q&A With Daniel Klausner on the IPO Market
When do you expect the IPO window to open in 2023, and what do you think is going to jumpstart activity?
Broadly speaking, the opening of the IPO window is driven, in large part, by investors, owners, and company expectations around valuation. In terms of when the IPO market is going to open and what will catalyze activity, we typically look at a couple different buckets. The first bucket is a macroeconomic bucket—what’s going on in the economy right now. Any time you’ve got an opaque economic environment, it’s challenging to project revenue, EBITDA, and earnings. Companies just don’t have as much clarity about their economic future.
The other elements include the Fed and inflation. Obviously, interest rates and inflation impact the market because some IPO candidates, frankly, are not profitable entities yet. And so, the present value of those future cash flows gets diminished any time interest rates rise.
Finally, the last driver to spark the IPO market reopening is that buyers and sellers have to shrink the gap on valuation, so to speak. I think we’ve seen some of that in the follow-on equity market. It’s a good indicator of the risk-on profile of market participants. Some of the recent follow-on equity offering activity we’ve seen suggests that sponsors and owners are getting more realistic about valuation on their existing public companies. They know they’re not going to see those IPO valuations again, but they do need to recycle capital and demonstrate returns to their LPs.
What kind of timing do you think we’re looking at right now?
Candidly, it’s been a bit of a moving target. Last year, we were hoping sometime in the first quarter of 2023; now we’re sitting in Q2 ‘23, and we’re hoping perhaps late summer, early fall, we’ll start to see some of the more well-known companies come to market. But it is obviously highly dependent on what the market does, where the S&P 500 moves, and where interest rates go.
So, in light of all those factors, from your point of view, what advice do you have for companies who are considering going public in current conditions?
I usually start off with optimizing their equity story, because that forms the basis of why investors would even want to invest in them: What do you want to do when you grow up? You need to be showing the market growth, but it needs to be well-established, recurring growth. Right now, the buyside is not interested in science projects or rocket ships, or black boxes. They want kind of an easy-to-understand business model, one that is not trying to disrupt the current TAM.
I’d say number two is around projections—making sure you’ve got robust, yet defensible, financial projections. In the IPO world, valuation is all based off projections, and what we saw with the class of 2021 IPOs. We saw many miss their projections and disappoint the street right after they went public.
Last, I would say go out and visit investors. If you’ve got a good equity story, you want to make sure you’re on those investors’ shopping lists when the IPO market opens up fully. We suggest that you visit them one or two or three times before actually asking them for capital. This gives them time to understand your business, get comfortable with management and your projections and your business model.
And frankly, in these meetings, they will be measuring you, as has been a longtime practice with the buyside.
Thanks for that. Last, outside of IPOs, what other avenues are companies taking advantage of?
We are seeing companies exploring their options in late-stage growth capital—a market that is open, but not as open as it was back in 2021. In addition, many companies are going back and shaking the tin cup, so to speak, with their existing investors. Although these insider rounds are sometimes necessary and critical to funding the business plan, the valuation mark that is created means less than if new investors provided that capital, because these new investors provide a more credible validation.
So, I would say companies are getting creative and utilizing structured equity and/or structured debt. But not all of these companies are going to escape distress with a combination of the business model or the projections, and then you fold in the valuation gap issue on top of this, and it becomes challenging to raise capital.
The capital markets present a unique situation for Houlihan Lokey because our Capital Markets Group covers the panoply of products and situations everywhere, from private debt, growth capital, minority investments, structured equity and debt, and then of course public equity IPOs. And we bring all of those products and all of that advice to private companies as they try to navigate these kind of choppy waters and figure out their options, such as: “Do I need to raise another giant ‘final’ private round?” or “Do I want to do two to three smaller rounds of debt or equity before I ultimately go public?” or “Should I get sold to another private equity shop?” And that deep bench of expertise and investor reach is why it’s great to be at Houlihan Lokey. We really are a full solution for our clients.
Daniel Klausner
Managing Director
Head of U.S. Public Equity Advisory