2010 started with high hopes for IPOs. The economy had been recovering since the summer of 2009, and investment bankers combed through the ranks of venture capitalists to drum up filings for tech IPOs. Early on over 9x more IPOs were filed than in recent years, but as it has turned out, US IPOs have raised the least amount relative to filings since 1999. More than half the filings have yet to complete, and over 60% have left IPO buyers with a loss, with 2/3 of them raising less than desired.
This isn’t just a Silicon Valley story. Many of these IPOs are private-equity backed and come from across America. The WSJ ran an op-ed called The IPO and the American Dream, observing that “access to capital markets remains the most reliable job creator we know.” Is it a surprise that more IPOs came out in Chinese than US capital markets? The op-ed urges policies changes in taxes, regulation (Sarbanes-Oxley of course) and immigration (more visas for the best & brightest), all good ideas.
A very insightful study by the accounting firm Grant Thornton takes a deeper look at what troubles US IPOs. They first issued their findings in Why Are IPOs in the ICU? and followed up with a final report, embedded below. You can read summaries from CFO magazine and the WSJ. The disturbing conclusion:
The market for underwritten IPOs, given its current structure, is closed to 80% of the companies that need it … We’ve killed the feeder system to the big leagues
They point to culprits beyond Sarbanes-Oxley, including the loss of analyst support (than you, Elliott Spitzer) and the rise of electronic exchanges, which reduces trading spreads and make it hard to make money on small cap issues. We used to have the ‘Four Horsemen”, investment banks which specialized in small cap IPOs, but they have been gone since 2001 due to unfavorable economics. Grant Thornton recommend a new “opt-in” market be created that fits the economics and needs of small cap IPOs.
In spite of all of this, chirpy optimism about what lies ahead is still prevalent. The pending list of VC-backed companies is over 4x higher than a year ago.
It is clear, however, that markets do not stand still. With the absence of IPOs, besides increased m&a activity, venture-backed companies are seeing the rise of a new Secondary Market, so named as the investors do not buy the whole company but buy shares of early investors and management. Facebook and Zynga, two very successful start-ups, have delayed IPOs until at least 2012 and accepted secondary capital. This trend is poised to accelerate in the years ahead, creating new paths to liquidity for emerging growth companies that run around the blockages of excessive financial regulation and the huge policy failure of killing the small-cap IPO.