Financial instruments such as stocks and bonds, constitute a growing proportion of financial transfers around the world. However, the majority of them are difficult to trade as the ability to sell their holdings, depends on the market in which these instruments are traded. There are two types of markets: the listed (public) market and the unlisted (private) market. These markets are a way for companies to finance themselves and a way for investors to invest their capital. They are predominant in the global economy, yet there are still significant differences between the two and great inequalities of access across them. According to the latest McKinsey report, private market fundraising reached a total of $778 billion in 2019. In comparison, the audit firm EY counted, among the more than 1,300 IPOs, that “only” raised $204.8 billion: almost four times less than unlisted companies market. Moreover, unlisted companies have seen their valuations increase 15-fold over the past 10 years.
Valuations have risen from 53 billion in 2010 to 715 billion in 2020 in favor of venture capital.
Why do such disparities between the two markets exist?
What are the investment barriers they face?
How does the structure of these markets affect our economy?
On the Private Equity market (shares not listed on a stock exchange), the traditional players are management companies, in the broadest sense. They act as an intermediary between (i) institutional investors or wealthy individuals — who mandate them to manage part of their funds, and (ii) high-potential companies. The funds managed by the management companies are invested in these promising companies, often young, with strong growth potential. The management company steers these companies as a shareholder in a more or less directive manner, the aim being the optimisation and maximum creation of added value by the company it supports. Indeed, if these goals are achieved, the company may be sold at a higher price or listed on a stock exchange. This enables the management company to serve a very high return on investment to the clients whose funds it manages. The private equity market is therefore a market with strong growth potential.
The unlisted market is also characterised by low volatility, which can be explained by the difficulty of quickly selling shares or bonds to a third party. Indeed, these are private, unlisted assets that cannot be traded on a stock market. The fact that investors in this market want to make long-term investments, makes it relatively impervious to cyclical fluctuations. This also leads to low liquidity, because the duration of capital immobilisation cannot be changed (or with great difficulty).
In recent years, the unlisted equity market has been given a new boost thanks to crowdfunding platforms. These platforms open up the private equity market to individual investors by democratising the use of unlisted equities. They also offer these financial instruments to smaller investors that wish to diversify their investments.
This market represents a strong interest for small and medium-sized savers in a context where the rate of return on “Livret A” savings accounts is around 0.75%, i.e. a negative net return taking inflation into account. In opposition, the unlisted market can serve a high-return on investment. In this context, savers, wishing to give meaning to their savings, see the unlisted market as a means to directly finance companies acting for concerning causes, such as health, new technologies, or environment. Indeed, the unlisted market is one place in the hands of the real economy, it directly finances companies that have an immediate and concrete need. The funds raised can be used to recruit new employees, buy equipment, or finance research. The impact of the investment can be directly observed.
However, as these are immature companies, the risk of insolvency on the private market is greater than in large public markets. Return on investment is unpredictable and only known at the end of the investment period when the company is resold or introduced on the stock exchange.
The main distinction between these two markets is the liquidity of the investment. It is virtually impossible for an investor to exit a private equity investment before it matures. Inversely, listed shares can be easily resold at any time. The investment timeframe of a private equity investment is therefore much longer than the timeframe of investment on listed markets (especially equities), above all when it concerns a ‘Fonds Commun de Placement dans l’Innovation’ (FCPI) or a ‘Fonds d’Investissement de Proximité’ (FIP) whose investment period is generally between 6 to 10 years. In crowdfunding, this constraint is lighter, because there are many projects with a term of only 1, 2 or 3 year(s). Equisafe wants to, among other things, make unlisted shares easily tradable by automating the rules of disposal and acquisition.
Private equity investments are not listed (obviously), volatility is therefore relatively low. This allows investors to be more independent of the capricious moods of the financial markets and the stress that can ensue. Indeed, on the listed market, the price (or rate) varies according to supply and demand. The price is determined instantaneously by the comparison between the stock of shares offered for sale and the stock of shares requested for purchase. If the number of shares requested by buyers is higher than the number of shares offered for sale, the share price rises and vice versa. This high price volatility may also be considered dangerous by some people. The notion of an ‘above-ground’ market often comes up when speaking about the world’s largest stock exchanges. Some people also fear that the capitalisation that these markets may be overvalued compared to the economic and social realities of a country. This leads to sudden corrections, as for example in mid-March 2020, during the crisis linked to the COVID-19 pandemic, when the CAC40 share price fell by more than 30% in a few days.
Predicting profitability is a key investment issue. While no one can predict the future, it is possible to anticipate future trends and dynamics for expected returns. In the public market, investors are remunerated annually in the form of dividends. To this may be added a capital gain or loss, depending on whether they sell their securities at a higher or lower price than the price at which they bought them. Even if major bullish (bull) and bearish (bear) trends emerge on the public markets, it is difficult to predict the future price and thus the realised capital gain. Dividends, on the other hand, are simulated each year to determine their approximate value. This allows investors to see a return on their investment.
In the private equity market, companies distribute very few dividends. This is because they are still expanding and need a high degree of self-financing capacity. This obliges these young companies to reinvest the profits made in the previous year of their business. The only opportunity for investors to make a profit, therefore, lies in the capital gain made on the resale of their shares. The resale price cannot be known in real-time or even accurately anticipated, making it a relatively uncertain market. Nevertheless, many crowdfunding investments, in the form of bonds, have a predefined return when they are opened to the public. Some investors in the unlisted market can, therefore, assess their return on investment in advance.
Finally, private equity in France offers tax advantages not available with investments in listed markets. FCPI / FIP funds, as well as crowd-lending or crowd-equity funds, can offer income tax reductions. It is often this argument that convinces individuals to invest part of their assets in the unlisted market.
At a time of slowing global growth, when listed markets are going through uncertain times investors need to diversify their portfolios. This need for diversification is coupled with a growing need for profitability. The unlisted market is able to meet these criteria. Unfortunately, the private market and the public market are two separate universes. Their access is very unequal: the majority of small and medium-sized investors do not have access to the private market. A strong disequilibrium has emerged. Economic logic would dictate that all economic agents should have the same access to financial markets, in a free and informed manner. This would allow an optimal allocation of resources and a permanent re-injection of liquidity into the economic fabric.
We are therefore led to ask ourselves two questions:
What practices should be developed to overcome these deficiencies?
How could a greater opening of the private market help the economy?