As we all know, the circle of life with most IPOs is as follows: funds flow into a seed-stage company, allowing said company to scale, grow, and innovate in ways unimaginable, and—if all goes well—IPOs come out the other end. Those returns are handed back to the respective investors, which can then be reinvested back into the system. Ideally, these IPO companies prosper, grow, improve, provide opportunities, and make the world a better place.
As 2022 borne witness, a series of external indicators that heavily influence the IPO market brought it to a screeching halt and the whole system has been somewhat clogged. Factors such as rising interest rates, discount rates, regulation, public market performance, economic growth, inflation, war, etc. had a very real impact on the conviction of companies to enter the IPO market.
EY’s 2022 Global IPO Trends Report highlighted that, in the Americas, there was a 95% reduction in proceeds from companies that went public in 2022 versus 2021. There were also 76% fewer IPOs in 2022 in the Americas than the year before.
When do things start turning around for the IPO market?
Currently, some believe that we may see changes starting in the third quarter of this year. Federal Reserve interest rate increases will need to slow and eventually stop which will lead to more stabilization with less inflationary pressures. If rates keep rising or if there is concern that rates may continue to rise, equity markets will remain choppy, and companies will be reluctant to go public. Interest rates are directly correlated to discount rates, which are used to calculate the present-day value of future cash flows of a company. When interest rates go up, so do discount rates, which can contribute to a lower valuation of a company.
This translates into investor’s unwillingness to pay the same prices for companies as their last funding rounds may have warranted. Besides factors like discount rates, demand is also part of the reason that shares of late-stage companies have fallen in price. In 2022, as a whole, investors retreated from the market to hedge losses and preserve capital, especially as the IPO market cooled. The lack of demand has also led to companies having less of a desire to IPO.
The extraordinary IPO market activity experienced in 2020 and 2021 is gone for now, and with investor’s preference for profitability and market stability, some companies will no longer be poised or positioned for a successful IPO. Investors and markets will need to get used to (at least for some time) substantially reduced valuation multiples and companies will likely be required, at a minimum, to have predictable revenue, be profitable, and probably a very secure $1.5-$2.0 billion plus market cap before going public.