Be Careful What You Wish For…

Everybody has an agenda, and we are all influenced by our personal experiences and biases. In reading many of the media reports after the release of the Grant Thornton study, A Wake Up Call for America, I have seen both thoughtful commentary in publications such as The Economist and the Wall Street Journal, as well as dismissive reports by some who find that the Grant Thornton study’s facts inconveniently stand in the way of their own agendas.

Certainly the ‘High Frequency Trading’ community of dark pools and hedge funds that currently account for 70% of daily trading activity in the U.S. don’t like this report.  Why?  Because reports like this stand in the way of financial market manipulation and drive home the point that not all financial innovation is good and that stocks are not fungible commodities.  The rapacious credit derivative and mortgage market financial engineers should have succeeded in proving the dangers of ‘one-size-fits-all’ thinking– to the world’s great detriment. Fortunately, responsible legislators who do show leadership, such as Senator Ted Kaufman (D) Delaware, are willing to call out the systemic risks of high frequency trading in publications ranging from the Financial Times to the Delaware News Journal .

And then there are those who look at the broken U.S. IPO market and simply dismiss the American equity markets for emerging growth companies today as “no longer engineered for brokers & bankers to make money via flipping over-valued startups to retail investors via institutional cronies”(from Paul Kedrosky’s blog).  I strongly disagree with this point of view.  It is  a fact that the lack of IPOs is harmful to job creation and to the American economy. Compounding the IPO drought is the fact that the entire NASDAQ market has shrunk—since December 2000 the NASDAQ has contracted by 38% to approximately 1,786 companies. So not only are fewer companies going public, more companies have been forced to merge or have gone out of business, which means there are fewer public companies to acquire other emerging companies. This is a very unhealthy situation, but it has been allowed to continue for years.

Again, the facts show that small growth company IPO’s can grow into global powerhouses–  the IPOs of Applied Materials, Adobe, Dell, Intel, Symantec, BMC, Computer Associates, EA, EMC, Fiserv, Intuit, Net App, Oracle, Paychex, Western Digital, Xilinx, and Yahoo!, which happen to all be venture‐backed companies, went public raising less than $50 million at various times between 1971 and 1996. These companies raised just $367 million in the public markets, and they account for 470,000 U.S. jobs today. Adjusted for inflation and measured in 2009 dollars, the $367mm in total dollars raised by this group equals $670mm, and only 2 of these 17 companies’ IPOs (EMC $80mm and Oracle$70mm) exceed $55mm in 2009 dollars. While today these companies are household names, let’s not forget that these companies were also largely unknown small cap growth companies when they first went public and that this impacts the entrepreneur most of all—how many companies that represent the next generation of household names will be still-born or acquired into obscurity because they cannot access the public capital markets today?

Graph for post

The IPO drought is a symptom of a deeper systemic liquidity crisis for small capitalization companies. Predictions that U.S. IPOs are about to come back in a meaningful manner are wishful thinking. The current threshold criteria for liquidity as defined by the dominant underwriters in the U.S. accommodate only a small minority of the viable private companies seeking public growth capital.  The severity of this untenable situation is compounded by a general lack of awareness among our nation’s policymakers that all of these factors are interrelated.

Today, if we are lucky enough to actually be in the aftermath of the global financial crisis, the risk capital available for market markers and small cap company underwriters to support America’s innovative entrepreneurs has diminished significantly.

The Grant Thornton report’s greatest value is in its thorough analysis, as it proves without a doubt that the U.S. capital markets for listed equities have been in systemic decline since 1997.  This condition is clearly not the result of the technology bubble or Sarbanes Oxley. Most importantly, the absence of U.S. IPOs negatively impacts American entrepreneurs most of all, regardless of whether they have venture capital or private equity backing.

The current IPO markets in the U.S. are not in equilibrium, and we are seeing this proven by the increasingly robust and growing offshore markets for new listings. Innovation is global, and risk capital is mobile.  Our country will continue to suffer the consequences of this trend as long as positive economics for supporting small cap companies in the market are absent.  Rational economic actors do not continue to risk capital in a loser’s game.  While this impacts venture capital exits, it isn’t about venture capital, it’s about capital markets.

The successful launch on October 30, 2009 of the Shenzhen GEM market for small cap companies, raising $20 billion for 28 small cap companies in one day, proves the point.  China leads the world in IPO’s in 2009; it would be a serious mistake to dismiss this as a flash in the pan or a “casino”. Risk capital will go where it is rewarded, and currently that is not in the United States.  Be careful what you wish for…


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