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March 22, 2011

A Call to Arms on the IPO Malaise and Inaction

I almost never agree with a single thing written on the Wall Street Journal editorial pages.  Yet, I found myself muttering "amen" to myself a few times as I read this morning's editorial on "Whatever Happened to IPOs?".  It is just stunning to me how little interest there seems to be on the part of a supposedly pro-business Congress and (more recently) Executive Branch on this one simple thing that would unleash innovation and jobs - watering down Sarbanes Oxley.

The IPO market has improved somewhat in 2011 and so perhaps that has taken some pressure off, but the fact is that the regulations and costs associated with an IPO are so overwhelmingly daunting for our young venture-backed companies that they simply avoid them altogether.  I used to hear from investment bankers that a company north of $100 million in revenue and consistently profitable can find a welcome public audience.   But recent conversations that I have had with bankers has carried a different, even more depressing message.

I am now being told by investment bankers that if a company's revenue is less than $200 million and the projected market capitalization less than $1 billion, they are at risk of being relegated into the "public company ghetto" - a sad corner of the public markets where you have no analyst coverage, no float and so no liquidity.  Your stock simply drifts down and down without any institutional support.  And so even $50-100 million companies in our portfolio and others - growing profitably and creating real value - look at the IPO as an unattainable goal.  I profiled a number of companies in New York and Massachusetts that fit this criteria in response to Bill Gurley's excellent piece (IPO Anxiety) from a Sillicon Valley perspective a few months ago.  But when I talk to CEOs and board members at these companies, they roll their eyes at the IPO prospect - it feels simply too unattainable.

Some complain that the source of the problem is the lack of mid-tier investment banks.  Others complain that the lack of analyst coverage is the issue.  In both cases, it's a cause and effect problem.  The cause is Sarbanes Oxley and the lack of volume.  The effect is that bankers and analysts follow the money.  If the rules were more relaxed, there would be more bankers and analysts, for sure.  This is the Information Age - analysis and bankers will follow opportunities.  They may not be as well known, but banks like Jeffries & Co, Needham & Co, GCA Savvian and now BMO are aggressively courting companies to help them go public and would be all over a more robust market for companies in the $300-600 million market capitalization range. 

In 2009, the National Venture Capital Association (NVCA) made this topic their policy focus.  They released a series of spot-on recommendations to help bring back the IPO market.  But then everyone got distracted with the financial crisis and (yet) more regulation related to SEC registration and battles over the tax treatment of carried interest.  I don't know if there have been any hearings or serious consideration on policy options to provide more liquidity for the IPO market since the NVCA's recommendations.  But clearly there's been no action.

It's time to beat the drum on this.  Surely we can find a group of members of Congress who are willing to match their rhetoric on fostering innovation will doing the hard work of loosening up Sarbanes Oxley.  The StartUp Visa movement has made terrific progress thanks to online, grassroots support.  Let's use that as a model for the IPO market.  John McCain's on Twitter (@SenJohnMcCain).  Send him a tweet and see if he's listening.


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I pinged my financial roommate about this, and it sounds like lack of analyst coverage of smaller tech outfits may be a red herring. His dad is the portfolio manager of a small-cap growth technology fund, and he gets research on just the stocks he follows from "at least 40 different firms," including bulge bracket banks (likely via the smaller banks they acquired), boutiques, and research-only firms. This isn't to say that they're aren't other firms that just aren't getting coverage, just that there's actually significant research/coverage/data volume out there.

"It is just stunning to me how little interest there seems to be on the part of a supposedly pro-business Congress and (more recently) Executive Branch on this one simple thing that would unleash innovation and jobs."

I hear ya. For me though it was a realization. About a larger concept. And a greater problem.

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