It’s time to debunk the myth that the United States' IPO market is in crisis, declining, in the ICU—or dead.
In February I penned a response to a gloomy New York Times OpEd that claimed, among other things, that the number of IPOs in the US is steadily declining. Since then this reality distortion has been repeated on the pages of the Wall Street Journal in an editorial forlornly titled Whatever Happened to IPOs. And it turns out that the Times and the Journal pieces followed on the heels of an alarmist January article written by well-known venture investor Alan Patricof entitled The IPO Market is Crippled—And It’s Hurting Our Country.
At their most benign these perceptions are just wrong and need to be cleared up. At their worst they are influential, contributing to powerful--and unnecessary--negative sentiment about the health of the US start-up funding environment and the functioning of its capital markets—both vital engines for growth, innovation and employment in the US economy.
So, let’s adjust the frame of reference. In order to understand today's market, each of these articles--and the Grant Thornton study that was a supporting document for Alan Patricof’s piece--compares IPO activity over the 2008-2010 timeframe to that of either the early 1970s or the 1990s. For multiple reasons these comparisons are simply irrelevant—and any conclusions drawn from them are likely to be wildly misleading.
First, IPO size. Patricof looks to the early 1970s as evidence of the failing state of today’s markets, citing the IPOs of Intel (which had an $8 million IPO), Datascope (a $2 million IPO) and Cray Research (a $10 million IPO) to support his thesis that deals today are too big, small companies are frozen out of the IPO market and this is killing venture investing and innovation.
But a venture investor who makes this claim appears to be willfully ignoring the facts of the present day market. He better than anyone knows that today's larger venture funds are investing in more rounds in later stages in bigger companies at higher valuations than they did in the early 1970s.
According to National Venture Capital Association (NVCA) data, in 2010 the average company valuation in venture follow-on rounds was $142 million. For those funds to reap adequate returns on their 2010 investments, the IPOs of their companies will, by definition, have to far eclipse the size of those of the 1970s.
It’s irresponsible to call this market unhealthy by this measure--IPOs are bigger, yes. And that does have implications for younger companies as they consider how to grow their businesses. But is the IPO market crippled--or do smaller companies lack access to capital? No.
Second, IPO volume. There are two issues with the accuracy of the concerns cited about IPO volume. The first is absolute, the second relative. In 2008 the total number of IPOs priced in the US market fell off a cliff, as the overall market dove during the financial crisis. Thirty one deals closed. Only one came to market in the normally peak fourth quarter.
Since then volumes have climbed steadily back, with 63 deals priced in 2009, 154 in 2010 and 36 so far this year, up 25% over the same period last year. These facts clearly belie the New York Times' observation that the number of IPOs is declining and the Wall Street Journal’s statement that “the overall trend [in IPOs] is down”. Also worth noting: in 2010 IPO returns were up 25%, the best year for US IPO performance since 2006.
And if the claim is that IPOs are down on a relative basis, IPO volume in the mid-1990s was off the charts, driven by the dot com boom, exceeding 500 deals a year during the peak period. Companies coming public included a significant number of low quality issuers, businesses without viable revenue models, led by management teams ill-prepared to run publicly traded companies. Many have disappeared, going quietly out of business or being acquired.
To use the volume of IPOs in the 1990s to measure where we are today--especially without acknowledging the turmoil of 2008, which the Grant Thornton study fails to do--throws the credibility of any subsequent conclusions and recommendations into doubt. Renaissance Capital, an independent IPO research firm, points to the years 2004 to 2007 as a more normalized benchmark to use to consider relative IPO volumes. During those years 200 IPOs priced per year, on average. If 2011 continues apace—and the pipeline indicates that it will, if market conditions hold up—the number of new issues this year will be right in line with that level of activity.
So what if, in fact, the US IPO market today is perhaps different than it was twenty, thirty or forty years ago, but vibrant, healthy, alive, as the Wall Street Journal itself declared in an online comment, US IPOs: King of the World, Again, published just weeks before its downbeat editorial? What if, in fact, all sorts of companies--US and foreign, large and small, with revenue and without, profitable and not, with venture funding, private equity backing and family owned--are successfully tapping the US markets (they are), with top tier underwriters (they do) or middle market investment banks (they have) and return shortly after their IPOs to execute follow on offerings (they can), what is the relevant conversation then?
Then the conversation becomes much more interesting. It creates choices and possibility where the crisis perspective does not. And it allows for effective, pragmatic consideration of the expanded menu of strategic growth and funding options available today to companies whose long-term goal remains public ownership.
Note: This article is Part One of a three part series. Next up: Crafting a Successful IPO: IPO Stories.
Photo: Colin Wetherbee