In a recent article published in the Hastings Law Journal (embedded below), Duke University School of Law Associate Professor Elisabeth de Fontenay discusses the relationship between the recent decline of IPOs and the deregulation of private capital. Professor Fontenay also spoke at the SEC’s recent Investor Advisory Committee on June 22 which discussed capital formation for smaller companies and the decline of IPOs.
Decline of IPOs?
Starting in the late 90’s, the number of IPOs per year has steadily dropped. During that same period, Congress and the SEC enacted several new regulations that were designed to open up private capital markets. Many of these new laws became and set the stage for what we now know as crowdfunding.
In her paper, Fontenay argues that the decline of IPOs can be attributed to the rise of private capital markets. That is, more companies are choosing to stay private rather than go public because recent crowdfunding laws, in part, have made it easier and cheaper. So is crowdfunding to blame for the decline of IPOs? No, that would be a mischaracterization and an oversimplification of an extremely complex system.
First, the paper mischaracterizes the decline in IPOs as do many publications that talk about how few IPOs there are compared to twenty years ago.
Yes, there was a sharp drop-off in the early late 90’s in the number of new IPOs each year, but that was a direct result of the dot-com bubble bursting. If you look at numbers pre-dot-com bubble, you’ll see that the number of IPOs today are not that much lower. If anything the dot-com bubble created an inflated number of IPOs and since that time numbers have readjusted themselves accordingly. There is a decline, but it is not as dramatic as some would have you believe.
Yes, there are fewer IPOs today than compared to 20 years ago and more and more companies are choosing to remain private for longer, but to infer a causal relationship between the two would be incorrect. Correlation does not equal causation. In fact, it could very well be that the deregulation of private capital markets was a symptom of the declining IPO market. That is, market forces could have made it less desirable to go public, thus pressuring companies to remain private longer. These private companies could have lobbied for less regulation to make it easier for them to raise capital without going public. In order to know with certainty what caused the decline of IPOs, one must look at real world situations and not academic theory.
Fewer IPOs but More Mature Capital
The overall landscape of public offerings is shifting. According to a report created by Cowen, there are fewer individual investors who purchase stocks for themselves as more and more brokerage firms migrate towards business models with asset allocation and management fees. Additionally, institutional investors, which are becoming larger and larger, are seeing increasing pressure to outperform their benchmarks. Investors, both retail and institutional, are less incentivized in purchasing stocks of small cap companies.
Investment banks are also seeing more profitability from alternatives to IPOs. Mergers and Acquisitions is becoming more profitable for investment banks as well as lending/debt financing given the current environment of low interest rates. It doesn’t make sense for investment banks to underwrite an IPO from a small cap company if they can make more money from an M&A deal or debt financing.
This all contributes to less demand for small cap public offerings as they provide less compelling returns for investors and other stakeholders compared to large cap stocks.
Issuers are also facing more reasons to stay private for longer as well. The increasing regulatory costs of going public imposed by Dodd-Frank for example, lack of liquidity in small cap markets, and a growing trend of the desire to maintain control all place pressure on private companies to remain private.
These are only a few of the reasons why the landscape of public offerings is shifting and why fewer private companies are going public.
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However, according to a report published by Ernst & Young, even though there are fewer IPOs today, the amount of capital being raised by IPOs is actually steadily increasing. That means larger more mature firms are opting to go public which in turn creates more stability.
With fewer small cap companies going public too early, there are less boom-bust cycles. Not only that, but more and more foreign companies are being publicly listed in the US while the number of US companies being listed in other countries has remained few and far between.
This all paints a picture of a relatively healthy public capital market. Yes, the number of IPOs are down but that is only one metric and doesn’t tell the whole story.
Private vs Public is Wrong
Finally, is there anything inherently wrong with IPO numbers declining?
Instead of focusing on private vs public, policy makers should be asking how to make capital markets as a whole better.
You have to look at capital markets as a whole to determine whether or not changes need to be made. Yes, there are fewer IPOs and more companies are choosing to stay private for longer, but dividing it into private vs public misses the point: Easing access to capital for emerging companies is good. So is providing more opportunities to investors.
Making it easier for private companies to raise capital may actually have a beneficial effect on public markets as can be seen by the current make-up of IPOs: more mature companies are conducting IPOs and are raising much larger amounts of capital. Furthermore, some reports estimate that 2017 is shaping up to be a very good year for IPOs. If IPO numbers do in fact rebound this year, it would give credence to the fact that healthy private markets are good for healthy public markets. Regulating private capital more is not a solution to the problem of declining IPOs because declining IPO numbers is not necessarily a problem.
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