The slow death of the plc

Growing businesses are increasingly turning their backs on the public markets.

by Adam Gale
Last Updated: 07 May 2019
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The sleek glass halls of the London Stock Exchange are home to an unexpected mystery. As the chaos of the trading floor gave way to instant algorithmic ingenuity and we all got distracted by the dot.com bubble, the global financial crisis and Brexit, our public companies have been slowly, but inexorably, disappearing.

At the beginning of 1999, there were 2,073 UK businesses with a listing on the main market of the LSE. Since then, they’ve been dropping off fast – and it’s still happening. At the last count, there were only 930 of them left. Even on the small-cap AIM market, which reached its peak in 2007, the trend of the last decade has been unmistakable, with numbers down nearly 50 per cent to 912 firms.

It doesn’t take too much sleuthing to deduce the immediate causes. There has been no decline in the number of start-ups or the number of companies overall – the long-term rise in both is well-publicised. There’s no indication British companies are choosing to list elsewhere, either: the London Stock Exchange has been one of the global success stories of the last few decades, attracting a great many foreign firms – besides, the decline in the number of quoted companies is happening everywhere, not least in the United States. We can’t even put it down to consolidation. Although we are living through a great wave of M&A activity, it works both ways: there’s divestment as well as consolidation, and the average size of a FTSE 350 company has actually decreased in real terms since the turn of the millennium.

All the available evidence points to one conclusion: businesses are choosing to turn their backs on that great engine of 20th-century capitalism, the public stock company. The question is why.

Initial and secondary offerings on the LSE in 2018 amounted to £35.9bn.

"If you believe the premise that the world is changing quicker than ever, then companies of all sizes need to innovate and take risks. The public markets are not an easy place to do that, because most investors in quoted companies are short-termist in their outlook," says Simon Rogerson, CEO and co-founder of Octopus Group, a private investment, energy and healthcare company that turned over £340m in 2017-18. "In the 1950s, the average holding period for a company was a decade; now it’s less than a year. You’re not investing in a business if you hold it for less than a year, you’re trading in it. We have absolutely no intention to go public, not now and not ever."

Rogerson is no outlier. There is a growing sense that the constraints on those running quoted businesses are tightening, with the likes of Sports Direct’s Mike Ashley complaining about being "stabbed in the back" by investors, and Tesla’s Elon Musk railing against the "major distraction" of quarterly reporting.

Ashley and Musk might not reflect the typical mentality of most plc chief execs who, understandably, are reluctant to comment publicly about their own shareholders. So, after scoping out a discreet venue away from prying eyes, we sat down with the CEO of one of the larger FTSE 250 companies, who’d previously confided their anxiety about the possibility of elevation to the FTSE 100.

"All I can see is the negatives. There’ll be a lot more scrutiny. You might say scrutiny’s a good thing, and it is, but the difference between medicine and poison is the dosage," he said, adding that his issue was less with regular reporting requirements, and more with the associated "governance nonsense" that he suspected would be even more severe in the bright lights of the FTSE 100.

Proxy advisors set arbitrary rules and will vote against you at AGMs if you don’t immediately comply. A classic example is executive remuneration, which has attracted increasingly hostile media attention. "There’s been a lot of abuse with pay but we’re all getting painted with the same brush. Like most people we benchmark salaries against the market, but now you can’t give any director a raise above the average employee’s increase without getting a vote against you. To make it worse, the government has stepped in and said that anyone who has more than 20 per cent of shareholders vote against them at an AGM has to go on a naughty list [the Public Register]."

You’d think that was a price you’d willingly pay for admission to the plc club, the benefits of which are manifold. Being quoted in the larger indices especially is a mark of a company’s credibility, and allows unparalleled, ongoing access to growth capital through primary and secondary listings; the liquidity of the shares, meanwhile, generally makes it easier to incentivise executives with stock options and gives the firm’s M&A ambitions a boost by allowing it to buy with shares as well as cash.

No one, including our anonymous CEO, who expressed no desire to delist, denies these benefits. But then the decline in the number of quoted companies is attributable neither to the increased ‘push’ of short-termist or activist investors – about whom there are innumerable horror stories – nor to some diminished ‘pull’ of the listed life, for which there is little hard evidence. The main reason companies are delisting, delaying listing or just choosing not to list is simply that they are trying their luck on the private capital markets instead.

There is no shortage of willing buyers. The world is awash with private money as never before; you just can’t immediately see it. Manhattan and Mayfair are full of funds with suspiciously low-key names – Three Hills, Palamon, InfraRed, Phoenix Equity Partners – and truly eye-watering assets under management.

The private option

In 2017, the value of private equity (PE) deals in the UK topped £29.4bn, according to Bain. To put that into context, initial and secondary offerings raised £35.9bn on the London Stock Exchange last year. Some private equity houses have hundreds of thousands of people working for their portfolio companies.

"The public model has always been the most popular way of attracting capital to scale your business, but now there’s so much money available from private equity, many firms just don’t need it anymore," explains Konstantinos Stathopoulos, professor of accounting and finance at Alliance Manchester Business School. Put simply, the costs associated with a public listing – fees to investment banks and underwriters, plus the ongoing costs associated with stricter governance rules – suddenly start to look very expensive when it’s possible to cut out the middle man.

Conditions have been almost perfect for the private markets in the 21st century. Tech companies with disruptive business models have created big and fast opportunities for venture investors with a high risk appetite. Persistently low interest rates have made private equity’s bread and butter, the leveraged buyout, more palatable.

Institutional investors, meanwhile, twice stung by the bursting of the dot.com bubble and the global financial crisis, have opened their coffers to private equity and venture capital funds as a way of making some much-needed, oversized returns. As Tim Hames, director general of the British Venture Capital Association, was quoted as saying: "If your ambition is to achieve extraordinary returns, then you’re not going to do that by buying shares in Marks & Spencer."

Private equity fund managers (known as general partners) have certainly had no difficulty convincing investors (limited partners) to part with cash – globally the sector raised $3.7tn between 2014 and 2018, according to Bain. If anything, they’ve struggled to know what to do with the money – as of the end of 2018, $2tn of that was ‘dry powder’, funds as yet unallocated, a ‘First World problem’ if ever there was one.

The net result is that there are many more options for entrepreneurs looking for funds. If you want to exit completely, there’s the option to sell to private equity or a trade rival, or IPO and then announce your departure a year or two later (public investors tend to like at least some continuity at the top). If you’re looking for growth capital, and maybe to de-risk a little, but have no intention of stepping down, then you could do a venture capital round, list on the main stock market, opt for a lighter listing on AIM – where firms get to choose their regulatory regime and have less onerous admissions requirements – or, in some cases, you can even elect to sell a minority stake to a private equity house.

A safe pair of hands

With so much capital available, most of these options are now possible at funding levels that only a main market listing was capable of reaching before, with several AIM IPOs each year fetching north of £100m, and some of the biggest VC rounds in the US reaching six or seven times higher, thanks to the deep pockets of SoftBank’s Vision Fund and the like.

The fact that there’s a choice is important here. The rise in public-to-private corporate divestments may be ultimately explicable as a consequence of better investor returns in the private capital markets, but the initial decision to go public or grow as a private company is not just the result of calculations by hard-nosed financiers. At the heart of the decision are the founders, a group with a distinctly sentimental attachment to their businesses, at least judging by their proclivity to refer to them as their ‘babies’.

Could it really be that private capital – private equity in particular – is a safer pair of hands for the apple of your eye than the institutional investors of the public markets?

"When we invest in a business, we’re committed for the long haul. We can only make money if everyone makes money, so we work operationally with the business on improving it," says Richard Swann, head of the buyout fund at Inflexion, a private equity house. "Compare that with the public markets, where a fund manager will be looking after hundreds of positions, deciding when will be a good time to sell."

The reason why there is so much capital available to private equity, he argues, is that it makes companies better. General partners are able to bring deep sector expertise and contacts to portfolio businesses. They can parachute in experienced managers who are able to see the wood for the trees and, if necessary, strip away the dead wood. They can incentivise existing executives with the prospect of colossal bonuses. Most importantly, private equity is willing to endure a year or two of losses for the sake of strategic investment.

All this makes a "vital" contribution to the UK economy, adds colleague David Whileman, who runs Inflexion’s partnership J capital fund for minority investments – and it has done for a surprisingly long time. "If you think back to the 1700s and what kicked off the Industrial Revolution, one of the key things was that it was possible to source capital cheaply and quickly, and that was because of individuals who used to meet in coffee houses and who were able to deploy money collectively. It was just private equity by another name."

But isn’t this private equity we’re talking about, an investment class more associated with ruthless, cost-cutting, asset-stripping predation than with altruistically laying the foundations for global economic development?

The most famous private equity houses, like Brazil’s 3G Capital, didn’t make their name or fortunes investing in growth businesses, but in sniffing out underperforming mature companies, tying them together, flattening overheads, extracting every drop of profit and making a killing on the sale, all within a three-to-five-year time span.

While there may be a debate about whether this is a bad thing, economically speaking (by optimising a business for the best possible margins, it squeezes out investment and smothers innovation; conversely, it clears out wasteful, undesirable companies, thereby extracting useful capital to fertilise more vital, younger enterprises) it’s hardly the kind of long-term support you might want for the company you nurtured lovingly for years.

Swann takes exception to this description. Private equity has changed, he says. "There are no easy wins these days – 95 per cent of private equity is about growth. I could name the ones with a cost-driven agenda on one hand." He points to Inflexion’s portfolio companies, which grew their collective headcount 20 per cent to 20,000 last year. "Yes, there’s a perception gap, but it’s decreased massively over the years as they realise we’re actually just ordinary people."

Multiple benefits

It’s not only private equity general partners who claim that their profession has reformed. It has other supporters in surprising places. "It’s about choice," says Marcus Stuttard, head of AIM at London Stock Exchange Group. "Some companies can really benefit if they get the right private equity partners, who can provide not just finance but also contacts and a management team who’ll stay for growth, which can be massively advantageous."

He points to a new spirit of co-operation between different types of investors, who realise that they are more often complementary than competitive – not least because many IPOs are made by businesses backed by private equity, which therefore benefits from a healthy stock market.

Unsurprisingly, however, Stuttard believes that going public is, for most companies of a certain size, still the best option. "It’s important that companies thinking about private capital understand what the motivations and time horizons of those backers are. There are a lot of management teams that get put on track to a sale earlier than they would necessarily want. I’d encourage them to contrast that with the public markets, which provide access to long-term finance and help companies raise repeat rounds as they grow."

Tony Pidgley, founder and chairman of FTSE 100 housebuilder Berkeley Group, has a less diplomatic assessment. "Say what you want about private capital, it’s expensive. Let’s suppose Brexit goes wrong and we have to shut the barriers down. If I’d got private money, the clock ticks and they want it back. And like most people, they want it back when it isn’t convenient to pay it back. I’d rather be in a public company that’s in my control."

Rumours of the imminent demise of the quoted company are, for now at least, premature. There’s no chance you’ll turn around tomorrow to find Shell has gone AWOL. At large scales, listing still offers such easy, ongoing access to capital that few growth-minded businesses can afford to pass it up. Even the Ubers and Airbnbs of this world eventually list.

But at all levels below that, there’s more choice today than there ever was. An ambitious entrepreneur can find examples of public and private businesses that are thriving, from Dyson and Pret a Manger in the private camp to Fever-Tree and Just Eat on the public side, and then the likes of ARM that have passed from one to the other with no meaningful effect on their prospects.

The options each have their pros and cons, which means thinking carefully before taking the plunge. But in a country where, according to the British Business Bank, only 41 per cent of SMEs take any form of external finance, starving them of potential to grow at pace and compete with international competitors, the choice can only be a good thing.

Images: Getty Images

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