Are Private Equity Blowouts Good for Stock Investors?

There’s growing evidence that private equity markets are beginning to overheat after several high-profile IPO flops. Investors in stocks should pay attention because private funding troubles are also a very public market affair.

In recent months, privately funded companies have discovered that public equity markets won’t give them a blank check. WeWork’s valuation plummeted from $47 billion in early 2019 to $8 billion in its bailout by Softbank this week, after its initial public offering was aborted because of concern about huge losses and its corporate structure. Shares of Uber Technologies and Lyft have fallen 27% and 39%, respectively, since their IPOs earlier this year. “The recent failures signal a return of a dose of sanity to the IPO markets,” the Financial Times recently wrote.

Day of Reckoning?

Private equity may be facing its day of reckoning. Historically, companies that relied on private equity funding to get started often chose to go public relatively early in their lifecycle. To access public market capital for future growth, companies traditionally needed to possess a proven business model that was profitable. The dotcom bubble in the late 1990s was an exception to the rule rather than the norm.

Record private equity fundraising changed the incentives. In recent years, with so much money readily available to private companies, many chose to stay private for longer to avoid some of the scrutiny faced by public companies—including the need to show a profit. Given the surplus of private capital today—and the scarcity of investment options—valuations and terms in the private markets may be reaching the point of being overheated.

Gauging the Impact of a Private Equity Shakeout

Cracks are beginning to show on several fronts. In addition to the IPO flops, still-private companies such as WeWork and Juul are now worth much less than their most recently priced rounds of equity. And companies that still have big losses will need to raise more capital just to stay in business.