Why pre-IPO investing is back in vogue

If you don't think public equities are getting a bit crowded, consider this. The past year saw a whopping nine million Australian adults invest outside their home and super. Just for scale, that is 46 per cent of all adults in the country. Of that nine million, 74 per cent (6.6 million) hold listed investments, and nearly one in four (23 percent) of them began investing in the past two years. But what other investment options are there ...

The pre-IPO private market is gaining more attention steadily, with funds now being established exclusively to capitalise on the private market. 

In the first of this three part collection, three of Australia's top pre-IPO fund managers provide a state of play on the current private market, analysing the stocks and sectors they gravitate to. They also outline the timeline for investing in companies at this early stage, and the benefits of getting in early. 

Responses come from: 

• Jessica Farr-Jones, Regal Funds Management 
• Jamie Odell, Ellerston JAADE Australian Private Assets Fund 
• Andrew Smith, Perennial Value Management

The endless benefits of the private market 

Jessica Farr-Jones, Regal Funds Management 

The pre-IPO market exists as to provide capital to unlisted emerging companies, in what is typically their final round of private fundraising prior to IPO. This typically occurs between six and 18 months prior to progressing to a public listing on a stock exchange, such as the ASX.

As both the number of Australian pre-IPO investors and overall pool of pre-IPO capital has grown significantly in recent years, it has become an increasingly common form of fundraising. Recent Australian IPO successes such as Aussie Broadband (ABB), Doctor Care Anywhere (DOC) and 4D Medical (4DX) all previously raised capital from investors in pre-IPO rounds, at a discount to the price offered to investors in the IPO.

As a result of the growth in the number of pre-IPO raisings, we have seen an improvement in both breadth and quality of deals in recent years.

In many cases, there is an opportunity to structure attractive terms to protect downside risk, with the added ability to also achieve an outsized return should the company execute well and become listed.

Another benefit of pre-IPO investing is the ability to get exposure to attractive companies via a capital raising round that is far less competitive. While most investors are restricted to investing only in publicly listed securities, we are able to take a meaningful position in a company before it lists. We have noticed the benefit of this particularly in recent months, where many public market investors have been disappointed with their allocations to recent “hot” IPO deals, given the high levels of demand.

The performance of the pre-IPO market is broadly linked to the strength of the underlying equity market and investor appetite for equity capital market and IPO transactions. Unsurprisingly - with the IPO window wide open and over 100 ASX listing in the 2020 calendar year so far – returns generated across the pre-IPO market have been very strong this year.

To date, a large proportion of the pre-IPO investments that we have made at Regal that have progressed to successful IPO’s on the ASX have been across the IT, technology, ecommerce and healthcare sectors. In software, this has included sales enablement company Bigtincan (BTH), PDF productivity player Nitro (NTO) and communication workflow company Whispir (WSP). Across technology, we have supported companies such as telehealth company Doctor Care Anywhere (DOC), family safety app Life360 (360), US buy-now-pay-later provider QuadPay (later acquired by Zip Co (Z1P)) and online book retailer Booktopia (BKG) in their pre-IPO raisings.

The emerging healthcare sector in Australia has continued to produce some excellent companies in recent years and we have been fortunate to be pre-IPO investors in companies such as respiratory diagnostics company 4D Medical (4DX) and soft tissue regeneration company Aroa Biosurgery (ARX).

We have been drawn to these sectors given they are often pioneering novel technologies in areas that are enjoying strong structural tailwinds and typically enjoy very high rates of organic growth. We continue to be attracted to these sectors, having recently made new pre-IPO investments in a number of companies across fintech, software, telehealth, ecommerce, and gaming.

A short term solution 

Jamie Odell, Ellerston JAADE Australian Private Assets Fund 

Pre-IPO investing falls into several categories. Firstly, there are pre-IPO convertible notes, which effectively means an investor is buying into an IPO at a discount to the IPO price. Given the price of the IPO might not be set, this enables the investors to get a fixed percentage return. These types of investments are usually quite short term – around 6-12 months.

The other type of pre-IPO investment is buying the equity of an unlisted company, with no fixed time for an IPO. For businesses performing well, with a number of options, this is generally more attractive as it limits the obligations of a company to list, which goes hand in hand with pre-IPO convertible notes. In our view, the best companies with the most choices will naturally gravitate to equity-style investments, which is why we have designed the Ellerston JAADE fund to be flexible.

Looking across unlisted markets, we have seen a significant uplift in deal opportunities since August. We have also seen the number of completed deals rise significantly, not just to pre-COVID levels, but to the highest level in the 10 years we have been making private investments.

We remain focused on technology-related businesses, and in particular, those with strong growth and a high proportion of recurring revenue.

Tech wins the private market race too 

Andrew Smith, Perennial Value Management 

It's been a very successful year for pre-IPOs. The percentage of companies listing that are raising pre-IPO rounds increased. It's a great way for the brokers to de-risk the IPO. They're getting investors in early, and we get more comfortable with the business. So by the time they go to IPO, we've known them for 12 to 18 months. We're looking to grow our investment at IPO, not looking to sell.

At the start of last year we were attracted to healthcare and tech. Generally, they're the sort of companies that need growth capital and have big global addressable markets, which are the types of attributes we're looking for. Healthcare, tech and consumer brands are the three sectors we focus on. 

It's also important to note how the quality of offers has improved. Software as a Service (SaaS) has made it much easier for companies to sell globally now. You don't need any hardware to go along, you're just selling over the internet. The quality of tech and the ability for Australian companies to compete has really changed, so you're seeing a higher prevalence of these types of companies, which is reflected in our portfolio. We own companies that offer construction software, invoicing software, health, med tech and crop techs. Everything being cloud-based has made it much easier for these companies to be global. That's been reflected in the opportunities we're seeing.

Conclusion 

The private market is just heating up. Some of Australia's favourite companies have started in here and grown to be success stories. One thing all these experts agree upon is that this is only the beginning for pre-IPO investing. 

Liked this wire? If you'd like to be updated when parts 2 and 3 of this collection are released, click the FOLLOW button under my profile. In the next instalment, the experts provide one company currently in their pre-IPO phase that looking promising ahead of their listing on the share market.