At a meeting on Thursday of the SEC’s Investor Advisory Committee, a panel discussed the declining number of IPOs, a topic that seems to be top of mind for many in the securities arena. Of course, there’s a reason for that; according to a panelist from EY, there were about 8,000 public companies in 1996, but only about 4,000 now. What happened?
(The following is based solely on notes, so standard caveats apply.) According to EY, what happened—largely the result of acquisitions and delistings—happened primarily by 2002; it’s not just a recent phenomenon. And much of the decline may reflect the popping of the dot-com bubble in the first years of the new millennium. Accordingly, some would argue that a number of those companies should not have gone public in the first place and that measuring against the height of the bubble is wrong-headed.
What’s more, the characteristics of IPOs are different now than they were in 1996. Now, according to one panelist, the average size of an IPO is $192M compared with only $62M in the earlier period. Currently, the panelists seemed to agree, the primary reasons for IPOs are investor liquidity, reputation building and price discovery, as well as, one panelist noted, the desire to use publicly tradable stock for acquisitions, while a couple of decades earlier, the primary motive was capital-raising. (This shift might explain the recent interest in direct listings—initial listings that do not involve underwritten capital-raising offerings).
There has also been a significant extension of the timeframe to IPO. One panelist observed that, in the past, the typical time to IPO was six to seven years, whereas now the timeframe is closer to ten to eleven years. As a result, he contended, more appreciation in value tends to accrue to private holders and less to public investors as companies go public at much higher valuations and do not experience post-IPO stock price growth at the same multiples as in the past. As examples, the panelist compared two highly successful companies, one that went public two decades ago and now has a market cap a thousand times its IPO valuation, almost all of which accrued to the public investors, and another which, 15 years later, had an enormous valuation upon going public, all of which accrued to its private investors, but now has a market cap only four times bigger.
One panelist reported that, when a number of CFOs were asked why they would decide not to go public, at the top of the list was the need to maintain decision-making control. In the private market, another panelist suggested, companies and investors have a kind of unspoken “pact” about long-term strategy. But, said one panelist, the rise of hedge-fund activism in tech and other product-cycle-driven public companies—a relatively recent phenomenon—has fueled concerns among founders and other management that they will be hampered in pursuing long-term strategic goals by activists with short-term perspectives. These companies fear that activity that may have significant long-term payout, but a near-term adverse price impact (e.g., M&A activity, change in product strategy, substantial investment in R&D), will draw scrutiny and intervention from hedge-fund opportunists. Hence, the recent prevalence of dual-class capital structures, which one panelist characterized as merging some private company benefits into a public company structure. Perhaps dual-class structures are a blunt instrument, the panelist indicated, but it’s one tool that is available. (Dual-class structures were discussed by the Committee in March. See this PubCo post and this PubCo post.) Tenure-based voting was suggested by a VC panelist as another possible remedy.
At the bottom of the CFO list of reasons not to go public was the burden of regulatory compliance. As one academic on the panel explained, while regulatory cost has been the dominant narrative, that narrative ignores the impact of deregulation of private-capital raising—it’s now much easier not only to raise private capital (e.g., changes to Reg D) but also to stay private (e.g., changes to the Exchange Act registration threshold). With low interest rates, debt has also been an attractive option for funding in lieu of an IPO. In addition, markets have provided more opportunities for liquidity through secondary trading of privately held shares. The panelist also argued that private companies enjoy the benefit of information asymmetry relative to public companies, which are subject to much more significant disclosure requirements.
The decline in IPOs has been disproportionately pronounced for smaller cap companies. Post-IPO performance can be a bit of lottery, said one panelist, and performance for some smaller companies can be disappointing. Many smaller companies have a harder time as public companies, suffering from significantly less research and fewer market makers, resulting in more difficulty in raising capital and less liquidity.
One anomaly, according to one panelist, has been the biotech market, where smaller cap companies need significant capital and are successfully able to access the public markets for multiple rounds.
Changes in the market were also raised as a cause for the decline. There may be less demand for IPOs because of the growth of passive index funds, which, by definition, do not invest in IPOs, as well as, panelists suggested, the underperformance of some smaller cap IPOs. Panelists also noted a lack of liquidity in the small cap market.
Among the suggestions to address these issues were increasing research and market activities for small cap companies through subsidies, improving liquidity by reducing the number of trading venues, continuing the tic-size pilot, reducing the concentration cap at funds and requiring transparency in short positions. Other suggestions seemed unlikely to gain popularity, such as reinstating restrictions on private capital-raising activity, eliminating disclosure asymmetry by increasing private company disclosure and reversing JOBS Act provisions to prevent companies from staying private as long.