Jeffrey Bussgang: 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.

Jeffrey Bussgang
is a general partner with Flybridge Capital Partners. He blogs here and tweets here. All opinions expressed here are entirely his own.

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6 Comments

  • We can fight it or go along with it, but IPO’s as a liquidity event are so last century.

    Even my friends who went public and then sold out (e.g. ConorMed) didn’t offer great returns to their VC investors. That’s because ConorMed went public at a valuation of $350MM, after VC investment of $170MM. Maverick and Highland, the two biggest investors, didn’t get much more than 2X, as they sold out just after the lockout period ended.

    ConorMed went on to sell to J&J for $1.4 billion. The shareholders were happy, but Maverick and Highland weren’t.

    Much simpler strategy: build medical devices (not companies) and sell them to BigCo’s. It’s more honest … and lucrative.

    -John Lonergan

  • Really Jeff? Water down the regulations so Entrepreneurs, VC’s and their LP’s can get their exit?
    You can’t really expect the public to agree that weakening regulations will benefit them. Btw, when you say “institutional support”, do you mean institutional cheerleaders covering the stock or institutional ownership.

  • I worry that Second Market and the like is equivalent (often) to derivatives. And we have seen how out of control those can get. Does anyone else think this? I’d be interested in hearing why it isn’t. Since I’m not an expert.

  • Wow! The WSJ is blaming the government regulation! We better react to that right away!

    The main point raised from actual sources is that the “public company ghetto” is the problem, which is a function of no longer profitable research departments.

    Another factor: PE firms and VC firms with tons of dry powder who are willing to pay outrageous multiples. Why go public when you can raise more money and mgmt can get more lucrative option packages?

  • Sam – Thanks for the comments, folks. I hope I was clear on why I think a healthy IPO market is important, but if not, let me expand on this. The goal of an IPO is not an exit. It’s a financing event and, in some cases, a credibility-enhancer for emerging companies. Although it’s true that the late-stage private equity market is hot right now for certain companies (particularly consumer Internet companies at scale), this market is very volatile and not accessible to all sectors. Having a robust public market provides companies with capital and credibility to build world-beaters. Where would Apple, Microsoft, Google and Genentech be today if they couldn’t go public? It’s not about exits.

  • Regulation is less than half the problem with the anemic IPO market. The real problem is lack of profits and talent in the IPO business.

    There isn’t enough money in IPO’s to attract high caliber talent into the ecosystem. We broke the economic foundation that our IPO market was built on – over simplified – the old $0.25 per share trading revenue supported a strong mid-cap investment banking business model. “Strong” meant that the 4 horseman could compensate partners (IB, research, sales, trading) at a levels that attracted the best and brightest. The 4 horseman routinely recruited away from the Goldman’s and the Mckinsey’s. Talented and trusted teams of bankers, research analysts, sales people and traders made the IPO market work.

    With the current $0.02 per share revenue stream there are only two ways to make the IPO biz work at an investment bank – either go for scale or reduce compensation. GS and MS make money by going for scale – big deals. The mid market firms have just cut compensation – and talent.

    It wasn’t regulation that caused revenues to go from $0.25 to $0.02 – it was innovation (Knight, Island, Instinet….etc) and a lack of understanding/respect for the role of talent in the IPO market structure.

    Regulation hasn’t helped. But, given the fact that most brilliant VC’s and smart IB’s don’t understand market structure – expecting the government to sort it out seems very socialist.

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