Connecting the Dots: How New Job Creation, IPO’s, and Venture Capital in America Are Intimately Linked
Everybody agrees that, without meaningful job growth, America will not emerge from its current deep economic funk. There is plenty of debate, however, over what drives that job creation engine in our country. I’ve recently read several interesting reports that touch on parts of the American job growth conundrum but do not tie them together. Pooling some compelling statistics from these various sources, I believe that the following conclusions are correct and interrelated :
(1) Job growth drives GDP growth;
(2) New company formation drives job growth;
(3) New companies create the vast majority of new jobs after their Initial Public Offerings;
(4) Increased Initial Public Offerings are required to increase job growth;
(5) If the total annual number of Initial Public Offerings (IPO’s) in the U.S. does not exceed 500, which studies show is the level required to support 3% annual U.S. GDP growth, the U.S. will not generate the job growth necessary to rekindle meaningful sustainable GDP growth in the U.S.;
(6) The most efficient fuel for this IPO engine is venture capital.
(i) Startups are responsible for virtually all the new jobs created in the United States since 1977 (Source: Kauffman Foundation)
“The Importance of Startups in Job Creation and Job Destruction bases its findings on the Business Dynamics Statistics (BDS), a U.S. government dataset compiled by the U.S. Census Bureau. The BDS series tracks the annual number of new businesses (startups and new locations) from 1977 to 2005, and defines startups as firms younger than one year old. The study reveals that, both on average and for all but seven years between 1977 and 2005, existing firms are net job destroyers, losing 1 million jobs net combined per year. By contrast, in their first year, new firms add an average of 3 million jobs.”
(ii) Clearing the backlog in the U.S. Patent Office (USPTO), could create 2.5mm new jobs over the next three years by contributing to startup formation. Source: New York Times Opinion article, Inventing Our Way Out of Joblessness by Hank Nothaft and Paul Michel, August 5, 2010 )
“1.2 million patent applications are currently awaiting examination by the USPTO …. each new issued patent creates between 3 and 10 jobs. Historic rates of patent grants suggest clearing the backlog could create 2.5mm jobs over the next three years.”
(iii) “Roughly 600,000 new businesses (that employ others) are started each year in the U.S.” . . .
(iv) “Roughly 1,000 businesses receive their first VC funding each year . . .This means that only 1/16th of 1% of new businesses obtain VC funding. . . .”
(v) “Since 1999, over 60% of IPOs have been VC-backed. This is an extraordinary percentage considering that only 1/16th of 1% of all companies are VC-backed.” “… it is highly unlikely that a company that does not take venture capital ends up going public. … Consistent with this success, venture capital has fueled many of the most successful start-ups of the last thirty years. … Four of the twenty companies with the largest market capitalization in the U.S.—Microsft, Apple, Google, Cisco—have been funded by venture capital.”
Source of (iii), (iv), and (v): “It Ain’t Broke: The Past, Present, and Future of Venture Capital”, by Professor Steven N. Kaplan of the University of Chicago Business School and Professor Josh Lerner of Harvard Business School.
(vi) Going back to the 1970’s it has been documented that 92% of the job growth in venture-backed companies occurs AFTER their IPO:
(vii) IPO’s currently account for 13% or LESS than all liquidity events for venture backed companies, down from 56% during the period from 1992 -2000:
(viii) The current IPO backlog and, more importantly, the poor aftermarket performance for the 85 IPOs priced in 2010 YTD, are symptomatic of a broken IPO pipeline:
According to David Weidner, author of the Wall Street Journal’s MarketBeat Blog, “Dealogic reports that the current 180-day backlog for IPOs now stands at 125 deals, a level three times higher than at the same point last year. The biggest industry waiting is computers and electronics with 23 deals seeking to raise as much as $4.8 billion, followed by finance, 19 deals, and healthcare, 17 deals. Private-equity and venture capital firms have been hard hit too. …While that door hasn’t closed, it has stalled, at least for the 125 issues waiting for the storm clouds to dissipate. So far, it’s been rough-going for most of the issuers who have taken the plunge. Of the 85 IPOs priced so far this year, only 28 are up. The total return for all issues combined is -1.97%, according to IPOScoop.com.”
(ix) The U.S. capital markets for listed equities have been in systemic decline since 1997, while every other major international equity market has been growing. This is due to systemic regulatory failure and the unintended consequences of ill-conceived regulation that disproportionately negatively impacts startups.
For the detailed study behind (ix) and the two slides above, read “Market Structure Is Causing the IPO Crisis– And More”, by David Weild and Edward Kim, published by Grant Thornton in June 2010.
Conclusion: If we don’t fix the IPO problem in America, we will not fix the job problem in America. Venture capital is an essential ingredient to this recipe for success. I can’t understand why our legislators and policymakers don’t understand this. If they did, there would be no higher legislative priority than promoting regulatory and tax reform to stimulate new capital formation and venture capital in the U.S. The fact that Singapore, Brazil, India, China, Chile, the U.K., and other countries have figured this out should serve as strong corroborating evidence to the accuracy of this conclusion.
In a Wall Street Journal editorial, Otellini’s Lament, dated August 27,2010, the editor quotes Intel CEO Paul Otellini’s recent comments: “…Otellini . . . warned a technology forum this week that without a change in U.S. government policy ‘thenext big thing will not be invented here. Jobs will not be created here. And wealth will not accrue here. Ultimately, we will face an inevitable erosion and shift of wealth– much like we are witnessing today in Europe.’”
I agree with Mr. Otellini, and it is no coincidence that my first book, Venture Capital: Theory & Practice, which I co-authored with Professor Mannie Manhong Liu of Renmin University of China, is in Chinese and is being published in China in October. For more on the book, see my next blog post.