Reviving the US IPO market

One of the principal reasons public markets exist is to provide a forum for individuals to invest in and profit from commerce, thereby giving capital to business people with ideas that society and the markets deem to be interesting and profitable. But are the public markets still functioning in this manner in the US – or has Wall Street’s bull lost its horns?

The number of listed companies in the US hit a peak of 7,428 in 1996. In 2015 that figure had fallen to 3,754, according to data from Alexander Ljungqvist, director of the Salomon Center for the Study of Financial Institutions at NYU Stern. It’s a problem that appears to be localized to the US: only six countries had a greater percentage decrease in listings between 1996 and 2012, according to the Journal of Financial Economics. They are Venezuela, Egypt, Colombia, Portugal, Lithuania and the Czech Republic.

The number of US IPOs in 2015 and 2016 also flagged due to market volatility and political uncertainty – but 2017 appears to have brought a change of fortune. As of the end of July the US public markets had raised $21.4 bn in stock, $1.4 bn more than in 2016. US President Donald Trump and Jay Clayton, his pick for SEC chair, are bent on continuing this momentum and reinvigorating the US public markets.

‘The substantial decline in the number of US IPOs and publicly listed companies in recent years is of great concern to me,’ Clayton said at a recent SEC committee meeting. ‘Some companies have shifted capital-raising activities to the private markets, where many Main Street Americans have limited access. High-quality companies may choose to go public at a later stage, after much of their early growth has already been achieved. Other companies may choose to stay private.’

During his SEC confirmation hearing, Clayton singled out Uber as a prime example of a company that has benefited from private funding, having raised $14 bn from venture capitalists and other investors, giving it a valuation of $70 bn.

Hard times

It’s certainly much harder to be a public company today than it was 20 years ago. Shareholder activism has increased dramatically, technology-enabled high-speed transactions have made the markets more opaque, and the 24-hour news cycle means a company is always just one scandal away from a share price drop. Concerns around exposure and lack of management control on the public markets were highlighted during the Snap IPO earlier this year, as the company offered only non-voting shares when it listed. Given these challenging circumstances in the public markets, why should firms go public, trade publicly and remain public?

‘There isn’t necessarily [sufficient] access to long-term permanent capital in the private markets,’ explains John Tuttle, global head of listings at the NYSE. ‘An IPO is a liquidity event for a lot of investors and employees, as well as a branding event for the company. You don’t necessarily get those opportunities at private companies.’

Easing the burden

With Trump and Clayton looking at ways to increase US IPOs, it’s an opportune moment for the stock exchanges to spend some time in Washington, DC. While companies that have just gone public are inherently more risky until they stabilize, the likes of Nasdaq and the NYSE have a long list of ideas about how to relieve the burden on public companies and make the prospect of trading publicly more attractive.

One issue for the SEC to decide is how to provide transparency for investors on material issues without exposing public companies to the reporting requirements that so many people feel are too onerous. Sarbanes-Oxley (Sox) is often targeted as a piece of legislation that imposes the greatest burden on public companies. At a recent hearing at the House of Representatives, Thomas Farley, president of the NYSE, said compliance with Sox Section 404 alone could cost millions of dollars in outside consulting, legal and auditing fees. For companies with access to private capital, the prospect of being exposed to this kind of cost and oversight could prove to be a deterrent.

Frank Hatheway, chief economist at Nasdaq, advocates for a sharper focus on what is material and meaningful as it relates to reporting and disclosure requirements. ‘The big philosophical point here is that corporate governance regulations [need to] return to a shareholder and investor protection focus and move away from some of the more politicized issues we have seen over the last few years,’ he explains, pointing to the conflict minerals rule as an example of a regulation that has been rolled back.

Both Nasdaq and the NYSE are also lobbying to revise the minimum stock ownership amount and holding period for a shareholder wanting to forward a proxy proposal. ‘We’ve seen an increase in the number of shareholder items on a proxy that come from a very small group of individuals, and they can keep them on a proxy for a long time before they drop off,’ says Hatheway. As it stands, any shareholder that has held more than $2,000 of a company’s stock for longer than one year can put a proposal on the annual meeting ballot. The Financial Choice Act 2.0, the Dodd-Frank replacement bill that is currently making its way through Congress, would require shareholders to own at least 1 percent of a company’s stock for three years in order to put a proposal on the annual meeting ballot. It’s a move that has been criticized by the Council of Institutional Investors.

Other issues currently being debated include requiring proxy advisory firms to register with the SEC, eliminating 10Qs and changing the 13F filing requirements so that companies can find out who has taken a position in their stock sooner than 45 days after the end of the quarter.

The SEC is responding to this feedback. Clayton’s first move as chair was to expand the purview of the Jobs Act to allow companies valued at more than $1 bn to privately file paperwork to publicly list, and he seems open to more regulatory changes. ‘We are striving for efficiency in our processes to encourage more companies to consider going public,’ he said in July.

The introduction of IEX as a listings venue later this year will also pose an interesting inflection point as it relates to transparency in the public markets. The exchange, which gained notoriety due to Michael Lewis writing about its speed bump in his best-selling book Flash Boys, has positioned itself as an outsider.

‘There are many companies that feel a lack of clarity about what is going on in the public markets,’ points out Sara Furber, IEX’s head of listings. ‘They don’t understand how it works – and they feel like no one is explaining it to them.’ 

Shrinking small-cap pool

As the public markets have become more complex over the last 20 years, the number of small-cap companies going public has decreased significantly. The share of small caps in the public markets has fallen from 60 percent in 1975 to 20 percent last year, according to René Stulz, director of the Dice Center for Research in Financial Economics at Ohio State University.

While many small caps are likely benefiting from the aforementioned boom in private funding options, there could also be some connection between the way the public markets have evolved and the dearth of sub-$1 bn companies trading publicly.   ‘There are true numerical impediments to banks buying small-cap firms,’ says David Collins, chief executive of Catalyst Global, a small-cap IR consulting company. Large buy-side institutions are less likely to take a position in a small-cap company because they’re keen to avoid the reporting requirements associated with owning more than 5 percent of a stock, Collins notes. The top sell-side banks are also less likely to cover small caps because they look for greater volume and liquidity, he adds.

When factoring this in with the expense of one-off IPO and mandatory reporting costs once public, it’s easy to see why companies might be deterred from listing their stock publicly. ‘We hear a lot of executives saying they don’t really understand the commitment and requirement of being a public company CEO, not just in terms of reporting and regulatory issues, but also with their obligation to shareholders,’ says Jason Paltrowitz, executive vice president of corporate services at OTC Markets.

There’s an increase in the number of companies dipping their toe into the water of the public markets without having to go through the costly process of registering with the SEC through Regulation D, according to Paltrowitz. ‘We’re seeing a lot of companies do what we call the ‘slow-PO’, where they raise money in the Regulation D market and slowly enter the public market,’ he says.

Looking beyond the short term

For small caps in particular, an IPO can expose a company to significant risks. If a firm finds itself struggling to match expectations, it can become vulnerable to short-termism, according to FCLT GLobal’s CEO Sarah Williamson. ‘Companies don’t want to go public because they will be subject to very short-term pressures of providing guidance and hitting that guidance instead of having  a long-term view,’ she explains.

Williamson points to recent research co-produced with McKinsey, which finds 55 percent of CFOs surveyed saying they would prioritize hitting quarterly guidance targets ahead of pursuing a minimum viable product opportunity that may have significant long-term benefits. 

Traditionally, the public markets have been seen as the endgame for many companies and – assuming they can stabilize their stock price – provide a long-term forum for fundraising. But short-term pressures around guidance and increased vulnerability to activists or takeover bids from larger competitors might be leading some companies to focus on their feet instead of the road in front of them.

What’s clear is that buoyant and vibrant public markets benefit society at large. While the Wall Street bull’s horns may have been blunted somewhat during the last two decades, it’s also clear there are enough actors waving the red flag in front of it to provide hope to those looking for greater liquidity.

This article appeared in the fall 2017 issue of IR Magazine