Typically, we think of private companies as raising capital primarily from investors such as venture capitalists and private equity firms. Contrary to commonly held notions, we document that private companies are increasingly raising capital from mutual funds. Across all venture capital-backed IPOs in 2016, 40% had raised money from mutual funds prior to going public. This compares to only 0% in 1995, and 3% in 2005.
Commensurate with this trend, we also observe a dramatic increase over the past twenty years in the number of mutual funds participating in private markets. Less than 14 funds invested in private companies each year through 2000, compared to over 90 unique funds in 2014 and 2015. The aggregate valuation of mutual funds’ investments in private firms increased from $16 million in 1995 to over $8 billion in 2015. Interestingly, while unicorn companies (commonly defined as companies with valuations of $1 billion or more) receive much attention, the majority of mutual funds invest in smaller companies.
We find that these developments provide benefits to both the private companies seeking capital and to the mutual funds. From the companies’ perspective, investments by mutual funds enable them to stay private longer. This enables them to achieve a higher level of development before becoming subject to the regulatory demands, increased disclosure requirements, and pressure from institutional investors associated with being publicly traded. From the funds’ perspectives, these investments have provided returns that are higher than public market index returns. Mutual funds’ returns are 67% to 161% higher on these private firm investments, compared to those on broad public market indices. Moreover, the returns on these investments are also virtually uncorrelated with public market index returns, meaning they provide a valuable source of diversification.
The greater availability of capital to private firms, combined with nontrivial costs of being publicly traded, means that the net benefits of public listing have decreased. If a vibrant IPO market is a policy objective, then regulators must consider both the ways in which the net benefits of being a public firm have changed and the ways regulations could be altered in the future to make public listing more attractive.