Equity Finance in the USA: An Introduction

Following a decline in equity capital markets activity in 2023, there has been increased market activity in 2024, with further increases expected in the first half of 2025. This article discusses key trends in the equity capital markets, including initial public offerings (IPOs) and follow-on offerings and alternative sources of capital from private investments in public entities (PIPEs) and convertible bonds.

Key takeaways include the following.

• The market for IPOs cooled significantly following its peak in 2021. It is still uncertain whether the 2024 IPO market can reverse the downward trend from recent years, following a lukewarm first half of the year.
• Despite the lukewarm IPO market, equity capital markets have been experiencing the strongest year for issuances since the peak in 2021, driven by a flurry of follow-on offerings in 2024.
• However, the IPO market may only have a small window to recover in the remainder of 2024 between the US Federal Reserve’s recent interest rate cut and the upcoming US presidential election. Despite this, 2025 is likely to see a strong reopening of the IPO market, assuming there are no unforeseen intervening macroeconomic events.
• Historically, PIPE transactions and convertible bonds have provided an alternative source of capital for companies that select not to or are unable to pursue more traditional debt or equity capital-raising methods. In response to challenging economic conditions in the past few years, including rising interest rates and underwhelming corporate earnings, PIPE and convertible bond activity has also declined significantly.
• Signs of recovery in these markets have been present in 2024 as the levels of PIPE transactions and convertible bond offerings have meaningfully increased in 2024 so far, compared to the same period in 2023.
• Although challenges still remain, stronger economic conditions, the US Federal Reserve’s recent interest rate cut, any further potential interest rate cuts and market volatility resulting from various economic and political factors, including the upcoming US presidential election, may provide tailwinds for the PIPE and convertible bond market in the remainder of 2024 and into 2025.

The IPO Market and Follow-On Transactions

IPO market trends

In the past decade, the volume of IPOs in the US stock market has experienced notable fluctuations. After a reasonably steady output of IPOs from 2014 to 2019, IPO volume nearly doubled from 2019 to 2020 and doubled again from 2020 to 2021. In 2021, a record-breaking 1,035 companies came to market. According to Nasdaq, the 2021 IPOs raised an aggregate of USD286 billion, representing an increase of 85% from 2020. 2021 also saw 121 technology companies come to market, representing the largest movement from the technology sector since the 2000 dotcom bubble era.

In March 2022, heightened interest rates paired with signs of an approaching recession cooled the IPO market dramatically. That year, IPO volumes plummeted, with fewer than 200 companies coming to market. 2023 experienced a further dip, with approximately 150 companies coming to market.

It is still uncertain whether the 2024 IPO market can reverse the downward trend of recent years. The IPO market is still experiencing challenges, such as recent market volatility, an upcoming election and less favourable macroeconomic conditions. According to Dealogic, US IPO issuances in the first three quarters of 2024 reached over USD32 billion from 155 deals, surpassing levels seen in 2022 and 2023, although still far below the levels seen in 2021. However, many IPO companies are failing to maintain returns, with IPOs in several sectors trading below their IPO prices. As of 31 July 2024, the average IPO return in 2024 in the technology and healthcare sectors has been 9.1% and negative 14%, respectively. On the other hand, companies in other sectors, such as energy, real estate, industrial and consumer, are averaging IPO returns of 85.8%, 24.4%, 22.9% and 20.3%, respectively.

As in previous years, the healthcare and technology sectors remain the most active for IPOs. Despite the overall decline in average IPO returns for 2024 so far for companies in these sectors, some of the most successful IPOs of 2024 also came from these sectors, including the offerings from Lineage Inc., Reddit and Waystar. All three of these companies have shown an upward trend in stock prices since their IPOs.

The financial and industrial sectors have also experienced notable upticks in IPO deal activity as investors gravitate towards reliable and established businesses. This shift indicates that investors may be moving away from growth companies and focusing on long-term stability, at least for as long as interest rates remain at elevated levels. While the volume of IPOs in the consumer sector has lagged behind the healthcare, technology, financial and industrial sectors, Dealogic reports that consumer IPOs have the second highest proceeds by sector, outpaced only by the real estate sector.

2024 follow-on offering trends

Despite the lukewarm IPO market, US equity capital markets are projected to experience the strongest year for issuances since the peak in 2021, driven by a flurry of follow-on offerings in 2024, as sponsors continue to search for liquidity and issuers seek to strengthen their balance sheets. Public companies (including those with significant private equity backing) and their shareholders have sold over USD90 billion in follow-on offerings in the first three quarters of 2024, outpacing the same period in the last two years. In the three days after Labor Day 2024 alone, ten follow-on offerings were launched for an aggregate value of over USD1 billion.

Secondary selling has played a significant role in this follow-on market activity, with secondary proceeds accounting for 59% of total proceeds from follow-on offerings in 2024 as of 31 July 2024, according to Houlihan Lokey.

In addition, follow-on offerings in 2024 have been on average priced at a smaller discount than in the past two years. A similar pattern of decreasing discounts for follow-on offerings was seen in 2020 and 2021, when demand for equity was high, indicating that demand for equity is returning.

Subsequent to follow-on offerings this year, stock prices have risen. On average, stocks sold in follow-on offerings rose 4.4% from their offer price one week after the sale. This number tops the 0.8% average gain seen in 2023.

Spin-off trends

There has also been a notable trend towards spin-offs while the IPO market is quiet. A spin-off is a strategically attractive way for companies to create value without affecting the shareholders of a parent company. Companies can also use spin-offs to slough off underperforming or non-essential parts of their business and create new, potentially more dexterous entities, as these disparate business units have the freedom to focus on their core operations and optimise their capital structure.

Globally, 2021 saw a record-setting 234 spin-off deals, and 2022 closely followed at 232 deals. A showing of 211 deals in 2023 demonstrated a consistent market trend resilient to the forces slowing down the IPO market, which has continued into 2024. In 2024, there have been 132 spin-offs globally as of 30 September.

In April 2024, 3M completed a spin-off of its healthcare unit, and General Electric spun-off its energy business, creating GE Vernova. The dramatic increase in spin-off activity in recent years has spurred the creation of multiple spin-off indexes, including the Bloomberg Spin-Off Index (BNSPIN), which has risen a notable 56% in 2024 as of 30 September 2024 and has outperformed the S&P 500 by approximately 35%. Since 2020, the BNSPIN Index has outperformed the S&P 500 by approximately 49% as of 30 September 2024.

Looking forward to 2025

Interest rate cuts and the upcoming US presidential election likely to impact IPO activity

Although there is a robust backlog of companies ready to move towards an IPO, there are several factors that companies must consider before taking the leap, including further potential interest rate cuts and the upcoming US presidential election.

Federal policy will be an important factor in companies’ decision-making, as a cycle of interest rate cuts is often seen as necessary to support successful IPOs. In early September 2024, policymakers at the US Federal Reserve signalled a readiness to begin a series of interest rate cuts in reaction to a rapidly cooling labour market. The resulting 50 basis-point cut at the US Federal Reserve’s mid-September meeting and any further potential interest rate cuts in 2024 and 2025 should facilitate increased IPO activity.

However, a cycle of interest rate cuts may not come soon enough to boost the 2024 IPO market before the US presidential election in November. Presidential elections historically have not had a large impact on IPO activity, but companies looking to conduct an IPO tend to avoid the two weeks before and two weeks after an election for fear of getting lost in the noise of the election.

Analysis from PricewaterhouseCoopers reveals that, since 1991, IPO activity has jumped in October of an election year, with an average of 37 IPOs that month – an average that is significantly higher than the average of 26 IPOs in Octobers of non-election years. In November of an election year, activity slows to an average of 20 IPOs, compared to an average of 30 IPOs in the same month of non-election years, before returning to a typical average of 24 IPOs in December. This suggests that the upcoming US presidential election is more likely to impact the timing of IPOs this fall rather than the overall volume.

In the year following a US presidential election, IPO activity has historically increased as policies stabilise and market outlook clarifies. IPO volume has increased following the past four presidential elections, regardless of the political party taking office.

Based on historical trends, the IPO market may only have a small window to recover in the remainder of 2024 between the US Federal Reserve’s recent interest rate cut and the upcoming US presidential election. Despite this, 2025 is likely to see a strong reopening of the IPO market, assuming there are no unforeseen intervening macroeconomic events.

Sector to watch: healthcare

Healthcare is one sector at the forefront of investors’ minds. The COVID-19 pandemic stimulated a deluge of investments in healthcare innovations. Since then, shifting market conditions have stemmed funding for healthcare companies, creating a backlog of dozens of late-stage digital health unicorns waiting for the opportunity to go public. In 2023, no digital health company entered the public market, and several digital health companies delisted, leaving only 43 publicly traded digital health companies on the market after a peak of 54 in 2021.

The tide could be turning for healthcare companies. Seven biotechnology companies conducted IPOs in the first six weeks of the year, including ArriVent Biopharma, which raised USD175 million, and Dyne Therapeutics, which raised USD345 million. In June 2024, healthcare payment software company Waystar Holding Corp. came to market, raising USD968 million in the biggest health tech IPO since 2022. Once the IPO market reopens, a number of healthcare companies are expected to conduct IPOs, clearing the backlog of companies waiting to go public.

Follow-on offerings and spin-offs are expected to follow existing trends

Although the IPO market may only begin to reopen in 2025, the follow-on market is likely to continue expanding for the rest of 2024 and into 2025, driven by the liquidity needs of shareholders. If interest rates remain high, equity financing will also become more attractive to debt-heavy firms. Looking forward, a slow and steady rise in follow-on offerings will indicate healthy equity capital markets.

Following trends from 2022 and 2023, the spin-offs trend will likely continue to be popular. Spin-offs have shown strong returns and have proven themselves to be a useful tool for value creation.

Alternative Capital-Raising Tools

Alternative capital-raising tools, such as PIPE transactions and convertible bonds, provide a source of financing for companies that select not to or are unable to pursue more traditional debt and equity capital-raising methods. These tools provide unique benefits to those seeking alternative sources of capital. However, similar to the IPO market, they have also faced various headwinds in the past few years. Although challenges and uncertainties remain, there are signs that demand for these products among both issuers and investors has returned, even faster than for the IPO market.

PIPE transactions

PIPE transactions are the private placement of the equity securities of a public company to a small group of institutional investors. The common types of securities sold and purchased in a PIPE transaction include common stock at a fixed price, fixed price warrants, convertible preferred stock and convertible notes.

PIPE transactions frequently provide a number of benefits to the issuer, including lower transaction expenses, market risk borne by the investor, limited regulatory requirements, and quick access to capital, including when other financing alternatives are unavailable. Because of these benefits, PIPEs are priced at a discount to the market price of the security, providing an attractive investment opportunity for investors.

Historically, PIPE transactions have been used by companies that have large capital requirements, such as those in the life sciences and technology sectors, as financing can be obtained quickly, the securities are sold at a smaller discount than in conventional private placements and they allow the issuer to expand its base of accredited and institutional investors. Sponsor-backed PIPEs provide additional benefits to the issuer by providing not only capital but also strategic partnerships, expertise and guidance.

The market for PIPE transactions has generally aligned with the M&A market, in part due to both strategic and private equity M&A deals using PIPE transactions for financing. For example, following a peak of M&A activity in 2021, the number of PIPE transactions also peaked. Based on data from PrivateRaise, the number of PIPE transactions doubled to approximately 2,660 in 2021 from approximately 1,290 in 2019.

In addition, PIPE activity has historically been correlated with interest rates, with PIPEs providing an alternative to high interest debt financing. For example, despite the significant decrease in M&A activity in 2023 compared to 2022, as interest rates increased over the same period, the number of PIPE transactions held steady at approximately 1,640 and 1,680 in 2022 and 2023, respectively.

Slowdown in PIPE transactions

M&A deal activity peaked in 2020 and 2021 as a result of record low interest rates, surging valuations and the popularity of Special Purpose Acquisition Companies (SPACs), leading to record levels of PIPE transactions as well. In those two years, there were more than 250 PIPE transactions in connection with de-SPAC transactions alone. From its peak, M&A activity has declined substantially due to several factors, including high interest rates, tighter availability of capital from traditional financing sources, valuation gaps between buyers and sellers, and the decline in SPAC transactions. The decrease in M&A activity has consequently led to a decrease in PIPE activity as well. However, in 2024, as economic conditions have improved, both M&A and PIPE activity has increased.

PIPEs in the healthcare and technology sectors

Regardless of the fluctuations in overall PIPE activity, companies in the healthcare and technology sectors have consistently relied upon PIPE transactions for capital raising. Since 2021, healthcare and technology companies have accounted for the majority of PIPE transactions. In 2023, healthcare and technology companies accounted for 51% and 20%, respectively, of all PIPE transactions. This trend continued in 2024 as healthcare and technology companies accounted for 52% and 14%, respectively, of all PIPE transactions in 2024 as of 30 September 2024. 

Convertible bonds

A convertible bond is a hybrid debt/equity security that provides coupon payments and principal return at maturity but can also be converted into a predetermined amount of equity securities for investors to capture upside potential. Convertible bonds offer a number of benefits to both issuers and investors. For issuers, the investor option to convert the bond to stock significantly reduces the coupon interest rate of the bond, reducing cash expenses for the issuer. For investors, convertible bonds are a stable investment that pay regular coupon payments and provide substantial downside protection while providing the potential to capture the upside of an equity investment.

Historically, convertible bonds have been issued by small-cap companies, commonly in the pharmaceutical and technology sectors. Recently, more large-cap companies have also issued convertible bonds as alternative sources of capital. For example, in 2024 numerous large-cap companies have issued convertible bonds, highlighted by Alibaba’s USD5 billion offering and followed by Albemarle’s USD1.75 billion offering and SoFi’s USD750 million offering.

Recent challenges for convertible bonds

The convertible bond market has faced considerable challenges in the past few years. The number of convertible bond offerings by public companies declined from 132 in 2021 to 50 in 2022, and recovered slightly to 74 in 2023.

As noted above, convertible bonds have been most commonly relied upon by small-cap companies. In recent years, these companies have been impacted by slowing economic growth, volatile public equity markets, decreasing company valuations and high interest rates. General recessionary concerns as well as concerns about individual companies, such as underwhelming corporate earnings, have caused investors to be cautious in their investment decisions. However, the market for convertible bonds appears to be recovering in 2024, with 87 offerings as of 30 September 2024, outpacing the same periods in each of the previous two years.

Looking forward to 2025: recovering markets for PIPEs and convertible bonds

The substantial headwinds that have depressed PIPE transactions and convertible bond transactions since 2021 still remain. These alternative capital-raising tools likely have a number of hurdles to overcome, including uncertainty relating to interest rates, underwhelming corporate earnings and volatile public markets. However, there have been signs that the markets for these transactions are recovering.

Interest rate cuts

In early 2024, improving market conditions and the expectation that the US Federal Reserve would cut interest rates led to a significant recovery in M&A activity, signalling positive investor sentiment and tailwinds for PIPE transactions and convertible bond offerings. The interest rate cut and the decrease of the target federal fund rate by the US Federal Reserve in September 2024 will likely lead to further recovery of convertible bond offerings and M&A activity, which could further contribute to increased PIPE transactions.

If past trends hold consistent, PIPE transactions may see an uptick in 2024 and in 2025 from the increase in M&A activity supported by interest rate cuts, although the increase in PIPE transactions may be slightly tempered by issuers turning back to traditional debt financing in a lower interest rate environment. Similarly, the expectation of further potential interest rate cuts in conjunction with positive economic conditions is creating a favourable atmosphere for convertible bonds. As improvements in market conditions make their way to mid- and small-cap companies, it is likely that the market for convertible bonds will continue to improve as these companies return to issuing convertible bonds.

2024 US presidential elections

Despite the positive sentiments in the market, there are still significant sources of uncertainty, specifically relating to the upcoming US presidential election. Although the levels of PIPE transactions and convertible bond transactions have not fluctuated drastically in response to past US presidential elections, volatility in the market resulting from the election may be favourable for these alternative capital-raising tools.

Both PIPE transactions and convertible bonds provide downside protections for investors. In PIPEs, investors are able to privately negotiate the terms of the transaction, usually for discounted prices. In addition, limited regulatory requirements allow investors to take advantage of quickly changing market conditions.

For convertible bonds, bondholders are able to take advantage of the downside protection provided by coupon payments and the upside potential provided by equity conversion, making convertible bonds a popular investment during periods of increased volatility. In fact, during 2020, when markets were volatile as a result of the last US presidential election and the COVID-19 pandemic, convertible bond markets performed very well, and the number of convertible bond transactions was the highest since 2007.

Conclusion

In the past few years, both traditional and alternative capital-raising tools have seen substantial declines in activity due to various macroeconomic and political factors. However, 2024 appears to be a turning point for many of these markets. Although the IPO market remains lukewarm, equity capital markets have experienced their strongest year since the peak in 2021, with follow-on market activity approaching 2021 levels and the IPO market likely to recover in 2025. Similarly, PIPEs and convertibles bonds, which offer alternative sources of capital, appear poised to continue their uptick in activity for the rest of 2024 and beyond, after a slowdown in recent years.

Although challenges and sources of uncertainty remain (most significantly the upcoming US presidential election), continued economic recovery and growth and the US Federal Reserve’s interest rate cut and further potential interest rate cuts are expected to provide tailwinds for an active equity capital market as we enter 2025.