Growth Capital‐Backed IPOs

Date01 November 2015
Published date01 November 2015
The Financial Review 50 (2015) 481–515
Growth Capital-Backed IPOs
Jay R. Ritter
University of Florida, Gainesville, FL 32611
Growth capital investing is the financing of growing businesses that are investing in
tangible assets and the acquisition of other companies. Growth capital is common in retailing,
restaurant chains, and health care management, and represents 12% of all venture capital (VC)-
backed initial public offerings (IPOs). Since 1980, investing in growth capital-backed IPOs
has produced mean three-year style-adjusted buy-and-hold returns of +25.2%, in contrast to
style-adjusted returns of approximately zero for other VC-backed and buyout-backed IPOs.
One-third of growth capital-backed IPOs are rollups and these have produced much higher
returns for investors than rollups without a financial sponsor.
Keywords: buyouts, growth capital, growth equity, initial public offerings, long-run perfor-
mance, reverse LBOs, rollups, venture capital
JEL Classifications: G14, G24, G32
Correspondingauthor: Warrington College of Business Administration, University of Florida, Gainesville,
FL 32611; E-mail:
I want to thank Dan Bradley (the referee), Rob Cousin, Harry DeAngelo, Chris James, Jerry Hoberg, Po-
Hsuan Hsu, Marc Lipson, Jim Parrino, and Ivo Welchfor useful comments, as well as seminar participants
at the Chinese University of Hong Kong, the University of Hong Kong,the University of Maryland, the
2014 PrivateEquity Research conference, and the 2015 New Trends in Entrepreneurial Finance conference
in Trier, Germany. Leming Lin and Diana Shao provided very able research assistance. I want to thank
Jennifer Bethel and Laurie Krigman, as well as Junming Hsu, for providing lists of rollup IPOs, and Ninon
Sutton for providing a list of IPOs that made acquisitions within a year after the IPO.
C2015 The Eastern Finance Association 481
482 J. R. Ritter/The Financial Review 50 (2015) 481–515
1. Introduction
Private equity investing is normally divided into two categories, venture capital
(VC) and buyout investing, but there is a substantial category of investments that
do not fit cleanly into either of these two categories. The early-stage investment in
Facebook by Accel Partners is easy to classify as a VC investment, and the leveraged
buyout (LBO) in 1988 of tobacco and food company RJR Nabisco by Kohlberg
Kravis and Roberts is easy to classify, but what about the minority investment by
Bain Capital in big box office supply chain Staples early in its life cycle? What about
the investment of Welsh, Carson, Anderson, & Stowe and GTCR Golder, Rauner,
LLC in Select Medical Corp., where the business plan described in the April 2001
initial public offering (IPO) prospectus is “we operate specialty acute care hospitals
for long term stay patients and outpatient rehabilitation clinics. We began operations
in 1997 under the leadership of our current management team and have grown our
business through strategic acquisitions and internal development.” I classify both
Staples and Select Medical Corp. as growth capital-backed.
I define a growth capital-backed IPO on the basis of three criteria: (1) the issuing
company has a financial sponsor that provides equity capital and actively invests; (2)
the financial sponsor is not necessarily taking a controlling position, unlike a buyout;
and (3) the issuer has been investing in tangible assets as a material part of its business
and/or making significant acquisitions, unlike pure VC. A more detailed discussion
is contained in Section 2.
This paper is primarily descriptive, and focuses on the 344 growth capital-
backed U.S. IPOs from 1980 to 2012 that I have identified. The first contribution of
this paper is to define and identify growth capital-backed IPOs, and document how
large a fraction of the VC-backed IPO universe they are. When just two categories
of financial sponsors are used, growth capital is a subset of VC. Among IPOs from
1980 to 2012, I classify 12% of VC-backed firms as growth capital-backed, and will
refer to the others as “pure” VC-backed. The growth capital-backed IPOs are almost
entirely in industries that are normally not associated with VC investing.Alternatively
stated, investors in VC and growth equity funds have exposure to industries outside
of the technology and biotechnology sectors, and the returns reported for this asset
class are not exclusively from those sectors. The conventional view is that venture
capitalists only fund technology and biotechnology companies. Thus, a contribution
of this paper is to show that this assumption is not valid.
The growth capital-backed companies tend to be moderate in size. I would
speculate that firms that are financed with growth capital are more likely to go public
than sell out in a trade sale, compared to pure VC-backed companies, so this 12%
number may be an overestimate of the importance of growth capital to the limited
partners (LPs) of VC funds.1
1On the other hand, I would conjecture that growth capital investing is less risky than the financing of
startups, where many investments are written off with no exit via an IPO or a trade sale. I do not know
which of these offsetting effects dominates.
J. R. Ritter/The Financial Review 50 (2015) 481–515 483
The second contribution of this paper is that it documents the long-run returns
on financial sponsor-backed IPOs from 1980 to 2012, and for the three categories
of financial sponsor-backed IPOs. I find that growth capital-backed IPOs have had
high long-run returns, outperforming both VC-backed and buyout-backed IPOs, as
well as outperforming IPOs that did not have a financial sponsor. To be specific, the
average growth capital-backed IPO produced a style-adjusted three-year buy-and-
hold return (BHAR) of 25.2%, measured from the closing market price on the day
of the IPO until the earlier of its three-year anniversary, delisting date, or December
31, 2014. For other IPOs, the average style-adjusted three-year BHAR is 2.6%
for VC-backed IPOs, 0.7% for buyout-backed IPOs, and 14.2% for IPOs without a
financial sponsor.For style adjustments, I control for both size (market capitalization)
and the book-to-market ratio. Ideally, I would also like to analyze the returns earned
by LPs on growth capital investing. Unfortunately, many funds invest in two out of
the three categories of privateequity, making it difficult to clearly identify the realized
returns without information at the transaction level.
In addition to reporting BHARs, I also report the results from Fama and French
(1993) three-factor time series regressions. In these regressions, the abnormal returns
on portfolios of VC-, growth capital-, and buyout-backed IPOs are economically
and statistically indistinguishable from zero, while an equally weighted portfolio
of IPOs without a financial sponsor underperforms by 40 basis points (bp) per
month. The difference in results for the growth capital-backed IPOs between the
high style-adjusted BHARs and insignificantly small three-factor model alphas is
primarily attributable to the differentportfolio strategies that are implicit. With equally
weighted BHARs, each IPO is being weighted equally and not rebalanced as gains are
compounded, whereas the time series regression results equally weight each calendar
month and rebalance each portfolio on a monthly basis.
The third contribution of this paper is to report the nonstationarity of the outper-
formance of VC-backed IPOs. When subperiods are analyzed, growth capital-backed
IPOs have outperformed the market in all subperiods when three-year BHARs are
used. The outperformance of VC-backed IPOs that has been documented by other
authors for the 1980s and 1990s, however, is not present for VC-backed IPOs from
1999 to 2000 or 2001 to 2012. Indeed, VC-backed IPOs from 1999 to 2012 have
done substantially worse than IPOs with no financial sponsor, reversing the pattern
documented by Brav and Gompers (1997) and others using IPOs from earlier peri-
ods. These findings, however, are sensitive to the portfolio strategy that is used. In
Fama-French three-factor calendar time series regressions, most categories of IPOs,
including VC-backed deals, have produced higher alphas (albeit without statistical
reliability) during the 1999–2013 period than they did from 1983 to 1998.
The fourth contribution of the paper is to report the long-run returns on a large
sample of rollup IPOs. Rollups are companies whose growth is primarily accom-
plished by acquisitions within an industry, rather than through internal (organic)
growth. Not all rollups have a financial sponsor. I classify 54% of rollup IPOs as
financial sponsor-backed. Of the growth capital-backed IPOs from 1980 to 2012

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