Late last month, the House Committee on Financial Services held a hearing addressing the topic of capital formation and the state of the US initial public offering market. While several witnesses focused on the rapid rise of SPACs, one witness pointed to the precipitous decline in IPOs and the fact that companies are remaining private as long as possible – thus cutting out smaller investors from the growth opportunity.
Scott Kupor, Managing Partner at Andreessen Horowitz, highlighted a disturbing trend in the decline of IPOs in the US:
“The raw number of IPOs has declined significantly: From 1980-2000, the US averaged roughly 300 IPOs per year; from 2001-2016, the average fell to 108 per year. With the benefit of increasing IPOs in the last few years, we are starting to see better growth: in 2020, there were close to 500 IPOs in the U.S., double the rate of the prior year, 103 of those being venture-backed companies. Second, the characteristics of IPO candidates have changed: fewer small companies are making it to the public markets. ‘Small’ IPOs – companies with less than $50m in annual revenue at the time of IPO – have declined from more than 50% of all IPOs in the 1980-2000 timeframe to about 25% of IPOs from 2001-2016.”
The increase in IPOs during 2020 was largely due to a significant boost from SPACs as they accounted for 50% of the IPOs. The rapid rise in SPACs has continued in 2021 – even while the Securities and Exchange Commission has increased its scrutiny of the SPAC market.
The decline in IPOs is driven by the fact that successful firms, on average, are staying private longer – shelving a public offering for as many years as possible. Kupor notes that from 1980 to 2000 the median IPO took place around 6.5 years after founding. Today that number is around ten years or more.
The reason companies are staying private as long as possible is multifaceted.
First, there is an ocean of private capital that has learned to jump ahead of the investment queue to capture the biggest returns in risky, but promising, ventures. This is aided by the fact that it is really expensive to take a company public. From the initial cost, including the extensive time and disclosure, to the ongoing demands of reporting, a good steward of investors’ money should not seek a public offering until they must.
Kupor states that while IPOs have declined in the US by 50% in the last 20 years – other developed countries have experienced a 50% increase in IPOs during the same time.
Kupor believes the US is at risk of creating a “two-tiered capital markets structure” where the bulk of gains accrue to wealthy individuals and institutions while retail investors are blocked from outsized gains generated by emerging firms. Kupor provides an example of how things have changed:
“Microsoft went public in 1986 at a $350 million market cap; today, Microsoft’s market cap exceeds $1.8 trillion. Contrast that with Facebook, which debuted in the public markets around a $100 billion market cap. While Facebook has performed well in the public markets, the returns to public market investors are about 8.5x. For public investors in Facebook to achieve returns comparable to those of Microsoft shareholders, Facebook would need to reach a market cap of $500 trillion, a number that well exceeds the total global market cap of all listed stocks.”
Kupor shares multiple suggestions as to how to improve public markets as well as advocating for greater access to private securities. One suggestion is to amend the definition of an accredited investor to broaden the definition to give more individuals access. He believes that “Congress and the SEC should look at ways to materially increase the number of individuals who would qualify under a revised definition.”
Kupor adds that retail investors should have more access to private markets:
“Today, un-accredited individual investors are permitted under the Crowdfunding rules to invest in early-stage seed companies, but are prohibited from investing in later-stage, pre-IPO companies. This makes little sense when you consider the differential risks of loss associated with those two very different stages of investments. To expand retail access to private market opportunities, Congress and the SEC should consider amending these rules to permit access to later-stage, pre-IPO companies. This, of course, needs to be accompanied by enhanced regulatory disclosures, but supporting venues [that] seek to enter this business opportunity through reformed regulation would expand access to high-growth opportunities.”
While expanding the ability to invest in private securities may democratize access to opportunity the SEC recently revealed its regulatory agenda that included a review of exempt offerings as well as a possible update to the definition of an accredited investor. Some observers are concerned that the SEC may turn things in the wrong direction by making the exempt offering ecosystem more stringent while raising barriers for accredited investor status, instead of removing them.
Supporting a robust entrepreneurial environment is beneficial to everyone and should be a key policy component of any elected official. Innovative early-stage firms create jobs and drive wealth and hopefully, the current administration will do more to support access to capital, streamlining the IPO process, while democratizing access to the private securities market.