How market volatility may affect private company liquidity

Editor’s note: The perspectives expressed in this commentary are the author’s alone. The following is a paid thought leadership piece from The Plaza Group at Morgan Stanley in Leawood, Kansas.

[divide]

Volatile public markets may affect private company liquidity in a variety of ways; Find out what this might mean for private company shareholders

According to recent research from Morgan Stanley at Work, equity compensation remains an effective strategy for employers to attract highly-mobile talent in today’s labor market. Yet the value of equity compensation may diminish if employees cannot sell it to make a profit. This is a common challenge private companies face. 

One of the advantages of an initial public offering (IPO) from the perspective of private company employees is that it may provide them with the liquidity to sell their shares. However, during times of market volatility, many companies choose to delay their IPOs. That was certainly the case in 2022 when worldwide IPO volume dropped by over 50% year-over-year.1 

In this type of environment, private company shareholders may turn to the secondary markets in search of liquidity. In fact, during the first half of 2022, secondary market transactions reached a high of $57 billion.2 Yet, despite delivering a source of liquidity, these deal volumes may present challenges for private companies. Here are some reasons why: 

Company valuations may decline 

While greater demand for private company shares may push up share prices in the short term, it may lead to fundraising challenges down the road. That’s because when private company shareholders sell their equity holdings, it may signal a lack of confidence in the company’s long-term growth prospects. 

And if existing shareholders are willing to take a discount on their shares — as many shareholders did in 20223 — that signal may get louder. This, in turn, may result in lower valuations should these private companies decide to go public. 

Liquidity pressure may build

During times of public market volatility, demand for liquidity may build as shareholders struggle to find buyers for their shares. Later-stage private companies may change their plans to go public and wait for more favorable market conditions. Any change to a company’s public offering schedule may lead shareholders to ask for partial liquidity to compensate for the change. In addition, equity holders with expiring options or high option exercise costs may look to their companies for liquidity support if public listing plans change. 

Rising to the challenge 

To counteract the declining valuations that secondary market sales may trigger, while relieving pent-up liquidity pressure, private companies may want to introduce employee programs that allow for partial liquidity. By giving early shareholders an opportunity to realize some of the value of their equity, these controlled liquidity events — such as tender offers — may give companies an opportunity to reward current employees while minimizing dilution. 

[divide]

1 S&P Global Market Intelligence. Global IPO activity cut nearly in half in 2022: just 20 launched in US during Q4. 2023 

2 PitchBook. PE secondaries market set to boom in 2023. 2022 

3 Crunchbase. The Market Minute: When There Are No IPOs, All Eyes Are On The Secondary Markets. 2022

[divide]

Disclosure: 

Article by Morgan Stanley and provided courtesy of Morgan Stanley Financial Advisor. 

The Plaza Group at Morgan Stanley is comprised of Teri L. Salach, CIMA®, CWS®, Wealth Advisor, Sheila K. Davis, CFP®, Financial Advisor, Jennifer L. Denning, CFP®, Financial Advisor, and David M. Salach, Financial Advisor, in Leawood, KS at Morgan Stanley Smith Barney LLC (“Morgan Stanley”). They can be reached by email at Jen.Denning@morganstanley.com or by telephone at (913) 402-5264. Their website is http://advisor.morganstanley.com/theplazagroupkc

This article has been prepared for informational purposes only. The information and data in the article has been obtained from sources outside of Morgan Stanley. Morgan Stanley makes no representations or guarantees as to the accuracy or completeness of the information or data from sources outside of Morgan Stanley. It does not provide individually tailored investment advice and has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The strategies and/or investments discussed in this article may not be appropriate for all investors. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a Financial Advisor. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. 

Morgan Stanley and its affiliates and employees do not provide tax or legal advice. Please consult your personal tax and legal advisors for matters regarding taxation and tax planning, and legal matters. 

Morgan Stanley P.O. Box 95002, South Jordan, UT 84095 USA 

Morgan Stanley at Work services are provided by Morgan Stanley Smith Barney LLC, member SIPC, and its affiliates, all wholly owned subsidiaries of Morgan Stanley.

The Plaza Group at Morgan Stanley may only transact business, follow-up with individualized responses, or render personalized investment advice for compensation, in states where they are registered or excluded or exempted from registration, http://advisor.morganstanley.com/theplazagroupkc

© 2023 Morgan Stanley Smith Barney LLC. Member SIPC. Privacy Policy CRC 5676642 5/2023