More Startups Aim to Keep it Private

Wall Street is dealing with new challenges in one of its bedrock businesses, taking young companies public, as more startups choose to stay private longer.

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A number of Internet, software and consumer companies are raising huge sums in private deals that enable them to postpone initial public offerings for years, if not indefinitely. Moreover, they often negotiate these private placements directly with investors, bypassing banks.

Initial stock sales are still thriving, despite the big private companies that have held out on an IPO. This past year was the biggest for U.S.-listed IPOs since the dot-com peak in 2000.

But the trend of companies staying private could present longer-term problems for banks. If companies delay or avoid going public, it could threaten the fees and other relationships—with investors, hot young companies and wealthy executives—that banks get from working on IPOs.

Some Wall Street firms are responding by beefing up their teams that work on the private deals, which also gives the firms another chance to build links with startups that may do an IPO later. The private deals could also generate a new stream of fees before the eventual IPO windfall.

“It’s obvious why banks are ramping up for more private offerings,” said David Erickson, a former banker who is now an operating partner at venture-capital firm Bessemer Venture Partners. But because company executives “have already met a lot of public investors by that time, the pitch for bankers is likely more challenging,” he said.

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In 2014, 40 startups were given valuations of $1 billion or more, doubling the number of such companies there were at the start of the year, according to Dow Jones VentureSource. Chinese smartphone maker Xiaomi Corp. is the most valuable, at $46 billion after a recent private round. The median technology company was 11 years old at its IPO in 2014, up from five years old in 2000, according to Jay Ritter, professor of finance at the University of Florida.

In large private fundraisings, companies often are doing themselves what they traditionally tapped banks to do in IPOs: get big mutual funds and other institutions as investors and achieve billion-dollar-plus market values. Uber Technologies Inc. didn’t use an adviser when it recently raised $1.2 billion, a deal that valued the car-service company at $41 billion.

Jay Simons, president of software development company Atlassian, said that when his firm raised $150 million in April selling shares to outside investors including T. Rowe Price Group Inc., he shopped the deal to a small number of investors his team knew and wanted to court as long-term holders. Atlassian didn’t use a bank on the deal, which valued the company at $3.3 billion, according to Dow Jones VentureSource.

“We’ve spent a number of years building direct relationships,” said Mr. Simons. For more complex private deals, he said, “there may be other situations where it helps to involve [banks] early in the process.”

As a result of these relationships, executives of long-private companies are often well-positioned to drive the IPO process themselves, including deciding which investors get stock. That role has been a critical one for banks, as it enables them to reward investor clients with hot shares.

Executives at Alibaba Group Holding Ltd. , already had a list of investors they wanted in their record-setting $25 billion IPO in September and even knew the price they wanted for the deal, people familiar with the company have said.

It isn’t clear how the surge in private placements might affect bank fees on IPOs. Big private rounds can lead to larger future IPOs, but larger IPOs tend to pay smaller fees, on a percentage basis. When banks get them, private-placement deals command a slightly higher fee as a percentage of the money raised than an IPO.

Banks trying to woo more private-placement clients said they provide a needed service. Companies are staying private longer partly because the number of investors interested in private deals has expanded significantly, they said. That growth increases the need for an adviser who can market the deal beyond an executive’s personal contacts, bankers said.

“There are more companies in the camp where the ability to do a private placement is not obvious,” said David Hermer, global head of equity capital markets at Credit Suisse Group AG . But “by widening the net beyond traditional investors, more companies are finding success” with big pre-IPO stock raises, he said.

The firm has hired a former Morgan Stanley banker to focus on pre-IPO private placements and other ways to raise capital, such as private convertible bonds, he said.

Goldman Sachs Group Inc. launched a private-placement unit in 2010 to work with companies that couldn’t go public due to market weakness after the financial crisis. The team, headed by New York-based Managing Director Craig Lee, has expanded as Goldman has come to see companies staying private longer as a long-term shift. The group worked on about a dozen private stock deals for technology companies in the past year.

“What’s changed is that companies are getting so quickly from startup to real traction,” said Dan Dees, global head of technology, media and telecommunications banking at Goldman. “You can’t just wait for the IPO pitch.”

Morgan Stanley has for many years had a private-placement group that works across sectors, people familiar with the bank said. It is adding two more senior bankers to the group, including the first to be based in Silicon Valley, the people said.

Mike Dinsdale, chief financial officer of DocuSign Inc., said the San Francisco company chose to work with Morgan Stanley on its $85 million private offering in March because it approached the deal like a public offering. The deal valued the electronic-signature software company at $1.6 billion, according to Dow Jones VentureSource.

“Our strategy was to cast a wider net and seed an investor base for an eventual IPO,” he said. “Using Morgan Stanley got us in front of investors we didn’t know.”

Some banks do private stock deals with the bankers who also do IPOs. J.P. Morgan Chase & Co. executed 15 stock private placements across sectors in 2014, for more than $4.5 billion, according to Mike Millman, co-head of Americas equity capital markets. The “private-placement business is a priority,” he said, with bankers working with investors who buy both IPOs and pre-IPO deals.

Deutsche Bank AG works similarly, relying on industry specialists for such deals, people familiar with the bank said.

Barclays PLC recently promoted a new senior banker, based in New York, who will focus in part on private tech-stock deals, according to Keith Canton, co-head of private capital markets, a group that works on both debt and equity deals.

“There were private tech deals in the late 1990s and early 2000s, but what’s changed is the scale and quality of the companies,” Mr. Canton said.

Boutique firms such as Allen & Co. are also in the tech private-placement business. In November, tech banking boutique Qatalyst Partners, started by Frank Quattrone, announced it had hired a Morgan Stanley private-placement banker, Anand Subramanian, to head private capital markets and raise money for firms from mutual funds, hedge funds and others.

Last year, startup advisory firm Battery East Group LLC hired former New York Stock Exchange head Duncan Niederauer to help private companies raise money from institutional investors.

Read More: WSJ

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