Why the return of IPOs matters for growth investors

The gradual recovery in U.S. initial public offerings (IPOs) that began two years ago could gain momentum in 2025.

What’s exciting about this prospect is the chance to invest in growing companies when they aren’t well understood by the market or represented in the indexes that underpin many passive funds.

What’s driving the recovery in IPO activity?

The value of new U.S. stock listings has only ticked up modestly from 2022, when rapidly rising interest rates and COVID-related distortions in some industries depressed IPO activity (Figure 1).

But many of the headwinds to IPO activity have diminished, likely creating a supportive backdrop for IPOs.

• Supportive equity markets: The strong returns posted by U.S. stocks last year, coupled with the Federal Reserve’s rate cuts, signal the potential for private companies to achieve favorable valuations in the public market.
• Timing: Concerns about how long the IPO window could remain open could foster a sense of urgency at companies thinking about going public.

Pent-up supply in private markets could fuel IPOs

At the same time, the private equity (PE) industry is keen to monetize a large backlog of unsold assets after the challenging environment constrained IPOs and mergers and acquisitions (M&A).¹

• Earnings: The performance fees that PE firms generate when they exit a successful investment can constitute a meaningful part of their profits.
• Client relations: The slowdown in exits has led to pressure from clients seeking liquidity and, in some instances, have contributed to questions about returns for recent fund vintages.
• Fundraising: PE firms that can demonstrate strong performance by returning capital to their investors should be better positioned to secure future funding commitments.

These dynamics, combined with optimistic comments from investment banks and publicly traded PE firms, suggest that IPO-ready companies could be preparing to go public if market and economic conditions remain accommodative.

Mid-cap investors and the IPO resurgence

Historically, many IPOs have landed in the micro- to mid-cap range.

However, the quality of businesses further up the capitalization ladder tends to be higher (Figure 2).

Part of this divergence likely stems from the maturity of mid-cap companies relative to the emerging growth businesses in the small-cap universe and the benefits that accrue to businesses with scale.

Adverse selection has been another factor. Companies increasingly have opted to stay private for longer, tapping a deep pool of available capital and avoiding the regulatory burdens and market volatility that publicly traded companies face. In other words, more and more businesses are skipping the small-cap phase in their lives as public companies.

This year’s IPO class is likely to involve more high-quality companies than the 2021 rush to go public. The businesses that investment bankers and sponsors choose to bring public in a recovery cycle’s early stages tend to be more established to help keep the IPO window open.

Market inefficiencies may create opportunities

In some instances, IPOs can present an opportunity to invest in quality companies when they are not as well known.

• Pre-IPO: Private companies have far less historical data available than their counterparts that are listed on the stock market.
• During the IPO process: Mandated “quiet periods” restrict what Wall Street analysts can say before the IPO and for a time thereafter.
• Post-IPO: Lighter brokerage coverage of small- and mid-cap companies can slow price discovery and increase the potential for dislocations.

These structural inefficiencies can create opportunities for firms that have built robust internal research capabilities spanning industries, asset classes, and public and private markets.

Still, investing in an IPO involves unique risks because these companies lack a public track record. Selectivity is critical.

Actively navigating potential pitfalls and opportunities in IPO investing

Large active managers may be able to give their clients exposure to IPOs that they might not otherwise be able to access.

They can also support a global team of experienced research analysts to offer both breadth of coverage and depth of knowledge.

When analysts have the time and resources to go beyond the numbers and develop a deep understanding of the competitive dynamics in their coverage universe, they may have a better ability to assess the longer-term risk/reward profile of companies that are going public.

Relationships built over the years with private companies and collaboration with fixed income analysts can also provide a relative advantage. 

What matters in IPO investing

Here are some of the considerations that are front of mind when considering whether to participate in a company’s IPO and potentially build a larger position over time.

• Business quality: Does the company have strong competitive advantages and staying power? Does it have the potential to improve its returns on invested capital beyond the market’s expectations? Here, working with analysts who have developed a deep understanding of individual industries can give portfolio managers an analytical edge.
• Strategy: Credible plans for long-term growth stand out. Could the IPO itself unlock value by providing access to capital that the company can deploy to drive growth? Sometimes going public can give a company more traction with potential customers and differentiate itself from rivals. We have seen this dynamic play out in disruptive areas like decentralized finance.
• Capable management: Familiarity with management from when the company was private can provide insights into the leadership team’s priorities, motivations, and operational prowess. Is the company focused on building for the long term? Does the management team understand what creates value in the public market?
• Valuation: Does the valuation leave room for upside because it does not fully reflect the company’s growth prospects?