The decline of the $10 million IPO, and why it matters(urgentspeed.com)
urgentspeed.com
The decline of the $10 million IPO, and why it matters
http://www.urgentspeed.com/applied_disruption/2010/04/why-ten-million-dollar-ipos-matter.html
10 comments
This entire article is just a bunch of moaning and bitching about how things are not like they used to be back in the olden times when stock brokers could make easy money without being too smart or working too hard by just answering the phone, executing orders and taking bribes for "research." (Note that stockbrokers can and still do make a lot of money nowadays, they just need to be much smarter and trickier about it.)
There's a lot of wrong things in there but let me point out the most obvious. He talks about the abundance of 10 million ipo's in the 80's and 70's and the dearth of them today without even mentioning inflation. Let's take the only concrete example he provided: that of Intel which had an 8 million ipo in '71. In 2010 money, by using the CPI, this is 43 million (and note that the CPI tends to underestimate inflation). Are there 40 million IPO's today? Yes there are.
This small list listing only the most recent IPOs on the NASDAQ shows at least two 40 mill IPOs:
http://www.nasdaq.com/reference/IPOs.stm
So a mere cursory examination of inflation completely destroys the only concrete example he provided.
There's a lot of wrong things in there but let me point out the most obvious. He talks about the abundance of 10 million ipo's in the 80's and 70's and the dearth of them today without even mentioning inflation. Let's take the only concrete example he provided: that of Intel which had an 8 million ipo in '71. In 2010 money, by using the CPI, this is 43 million (and note that the CPI tends to underestimate inflation). Are there 40 million IPO's today? Yes there are.
This small list listing only the most recent IPOs on the NASDAQ shows at least two 40 mill IPOs:
http://www.nasdaq.com/reference/IPOs.stm
So a mere cursory examination of inflation completely destroys the only concrete example he provided.
Yeah but the economy is a lot bigger now too. It is an indisputable fact that the U.S. IPO market smaller in both size and frequency.
It isn't the only cause, but Sarbox has hammered public companies with huge regulatory costs for absolutely no benefit-- indeed, there is some evidence that corporate malfeasance is easier today because the rules are so complex, the true risks are easier to bury. SarBox certainly didn't stop the corruption in public mortgage finance and investment banks. You could argue that the law was tougher pre-SarBox-- at least Enron and WorldCom crooks went to jail.
It isn't the only cause, but Sarbox has hammered public companies with huge regulatory costs for absolutely no benefit-- indeed, there is some evidence that corporate malfeasance is easier today because the rules are so complex, the true risks are easier to bury. SarBox certainly didn't stop the corruption in public mortgage finance and investment banks. You could argue that the law was tougher pre-SarBox-- at least Enron and WorldCom crooks went to jail.
[...] at least Enron and WorldCom crooks went to jail.
Good point — modern crooks got bonuses and their companies were saved from bankruptcy.
Good point — modern crooks got bonuses and their companies were saved from bankruptcy.
"More recently, watchers of the New York tech scene will recall Google’s purchase and shutdown of Dodge Ball."
Interesting... I wonder when Google went public... undoubtedly it was back in the heyday of small tech IPOs, otherwise they would have had to sell themselves!
Seriously though:
His other example, Wal-Mart - inflation adjusted would be >$100mm today at IPO.
To expand on hristov's list, some recent, smaller IPOs:
AcelRx: $85mm market cap (ie. post-money)
Kip's Bay Medical: $130mm market cap
Trunkbow International: $170mm market cap
Ossen Innovation: $87mm market cap
SGOCO: $80mm market cap
UniTek: $150mm market cap
through the midpoint of November. Some slightly larger ones as well that I've skipped.
Not to say that increased regulation and disclosure requirements have had a negligible chilling effect on the decision to go public, but this blows it out of proportion.
What may be a legitimate worry is that companies are choosing to stay private through sales to VCs and PE funds, saving millions in public company costs and the time that would otherwise be devoted to dealing with the general investing public. Whether this is a good or bad thing is debatable, but it does keep these companies out of reach for certain investors.
Interesting... I wonder when Google went public... undoubtedly it was back in the heyday of small tech IPOs, otherwise they would have had to sell themselves!
Seriously though:
His other example, Wal-Mart - inflation adjusted would be >$100mm today at IPO.
To expand on hristov's list, some recent, smaller IPOs:
AcelRx: $85mm market cap (ie. post-money)
Kip's Bay Medical: $130mm market cap
Trunkbow International: $170mm market cap
Ossen Innovation: $87mm market cap
SGOCO: $80mm market cap
UniTek: $150mm market cap
through the midpoint of November. Some slightly larger ones as well that I've skipped.
Not to say that increased regulation and disclosure requirements have had a negligible chilling effect on the decision to go public, but this blows it out of proportion.
What may be a legitimate worry is that companies are choosing to stay private through sales to VCs and PE funds, saving millions in public company costs and the time that would otherwise be devoted to dealing with the general investing public. Whether this is a good or bad thing is debatable, but it does keep these companies out of reach for certain investors.
I follow you except for the note about CPI underestimating inflation. There's actually a lot of debate about this (see http://en.wikipedia.org/wiki/United_States_Consumer_Price_In... for an informal look), and I personally think it overestimates it.
It's controversial in the UK too. My colleague, Simon (who used to be the FT's stats editor), writes about it on our data blog:
http://byline.timetric.com/2011/02/14/uk-inflation-bad-decis...
(which has subsequently been picked up by a couple of UK papers.)
http://byline.timetric.com/2011/02/14/uk-inflation-bad-decis...
(which has subsequently been picked up by a couple of UK papers.)
Doesn't anyone else see a huge opportunity here? If we set aside regulation for a moment, there is a _huge_ demand for a liquid market for privately held stock. Both investors and companies would have huge benefits from being able to trade stock on a market that's not connected to the traditional exchanges. I'm standing on the investor side of things, annoyed out of my head that it is impossible to invest in the companies I'd want to unless I had a hundred million dollars.
There are probably _huge_ regulatory hurdles to a problem like this, but it would be interesting to see where the excact problem lies. Practically, you'd need to attract enough investors to make the market reasonably liquid, as well as gain enough confidence from the market at large that people would want to participate.
Does anyone know what regulation prevents someone from doing this?
There are probably _huge_ regulatory hurdles to a problem like this, but it would be interesting to see where the excact problem lies. Practically, you'd need to attract enough investors to make the market reasonably liquid, as well as gain enough confidence from the market at large that people would want to participate.
Does anyone know what regulation prevents someone from doing this?
> Does anyone know what regulation prevents someone from doing this?
The same regulation that pretty much defines modern securities - the Securities Act of 1933. It basically states that securities cannot be offered to the public without first being registered with the SEC, and the company must report all material information related to the security - essentially these requirements are the reasons that companies are avoiding IPOs in the first place.
> there is a _huge_ demand for a liquid market for privately held stock
Privately held stock is, by definition, privately held and not publicly offered on a liquid market. The only potential loophole I see here is that accredited investors (individuals w/ net worth > $1 mil or income > $200k/yr) are exempt from these rules as they are considered "sophisticated investors". However, a market that's only open to accredited investors probably wouldn't be very liquid.
The same regulation that pretty much defines modern securities - the Securities Act of 1933. It basically states that securities cannot be offered to the public without first being registered with the SEC, and the company must report all material information related to the security - essentially these requirements are the reasons that companies are avoiding IPOs in the first place.
> there is a _huge_ demand for a liquid market for privately held stock
Privately held stock is, by definition, privately held and not publicly offered on a liquid market. The only potential loophole I see here is that accredited investors (individuals w/ net worth > $1 mil or income > $200k/yr) are exempt from these rules as they are considered "sophisticated investors". However, a market that's only open to accredited investors probably wouldn't be very liquid.
> Doesn't anyone else see a huge opportunity here?
Forgive my ignorance, but isn't this essentially what sharespost and secondmarket are doing?
Forgive my ignorance, but isn't this essentially what sharespost and secondmarket are doing?
Hehe, forgive _my_ ignorance..these companies are doing pretty much what I was suggesting. I'm not that versed in the details of reasonably young companies.
Let's talk about the list of software companies that are probably going to IPO in the next couple of years: Facebook, Groupon, Yelp, Pandora, LinkedIn, Zynga, Twitter
One of the big differences of today's IPO market, is that many of these company's founders have been able to take some money off the table. The founders are rich and early employees are able to have some liquidity via secondary markets. At the same time, there's a lot more capital available to large companies at this stage than there ever was. (See DST's recent investments, Andreesen Horowitz's recent investments). So, the typical reasons that have pushed companies to IPO aren't there any more. That lets technology companies run for a lot longer before they have to IPO or get huge acquisitions.
So, while there haven't been as many software company IPO's as there have been in the past, my gut is that the ones that we do have are going to be larger and more successful.
One of the big differences of today's IPO market, is that many of these company's founders have been able to take some money off the table. The founders are rich and early employees are able to have some liquidity via secondary markets. At the same time, there's a lot more capital available to large companies at this stage than there ever was. (See DST's recent investments, Andreesen Horowitz's recent investments). So, the typical reasons that have pushed companies to IPO aren't there any more. That lets technology companies run for a lot longer before they have to IPO or get huge acquisitions.
So, while there haven't been as many software company IPO's as there have been in the past, my gut is that the ones that we do have are going to be larger and more successful.
A $10 million IPO doesn't make any sense when they will have to spend 20 percent of the IPO money on meeting Sarbanes/Oxley requirements in the first year. It it costs about $2 million a year to meet those requirements.
I'm not sure I understand point #2 (decimalization). Can someone explain what he is getting at?
Stocks used to be priced in eighths of a dollar per share (that is, 12.5 cents). A few years ago, the exchanges switched to pricing them in cents, like everything else. This was "decimalization".
What's not obvious is why this guy thinks that this altered IPOs in any meaningful way. (I'm not even sure why he thinks it altered trading volumes, which is how he claims it affected IPOs.)
But it fits a different pattern, in this article. It turns out that, at least according to this guy, every single change in the capital market structure since, I don't know, 1992 was somehow bad for small IPOs.
Item #3 is "the rise of the internet brokerages." You might think that having a broader customer base would make it easier to sell stuff, but no. Bad for IPOs!
Item #5 is Eliot Spitzer reining in fraudulent "analysis" at various Wall Street firms, which was getting people to invest in stuff they didn't otherwise understand. (Which, in the world I live in, happened to a great extent through internet brokerages, but ... never mind.) It turns out that chasing fraud from the marketplace is Bad for IPOs!
And so forth.
There are some good points here --- Sarbanes-Oxley regulation is a big deal, and so is consolidation on Wall Street. But some of this other stuff really does strike me as a bit of a stretch.
What's not obvious is why this guy thinks that this altered IPOs in any meaningful way. (I'm not even sure why he thinks it altered trading volumes, which is how he claims it affected IPOs.)
But it fits a different pattern, in this article. It turns out that, at least according to this guy, every single change in the capital market structure since, I don't know, 1992 was somehow bad for small IPOs.
Item #3 is "the rise of the internet brokerages." You might think that having a broader customer base would make it easier to sell stuff, but no. Bad for IPOs!
Item #5 is Eliot Spitzer reining in fraudulent "analysis" at various Wall Street firms, which was getting people to invest in stuff they didn't otherwise understand. (Which, in the world I live in, happened to a great extent through internet brokerages, but ... never mind.) It turns out that chasing fraud from the marketplace is Bad for IPOs!
And so forth.
There are some good points here --- Sarbanes-Oxley regulation is a big deal, and so is consolidation on Wall Street. But some of this other stuff really does strike me as a bit of a stretch.
Item #3 makes sense in that a lot of 'casual money' or individual traders do not have access to information about IPOs much less the ability to get involved in the offering. These investors previously were forced to use an advisor or at the very least a broker who is far more in tune with what is new on the market then the individual typically is.
Stocks used to be priced in eighths of a dollar. So if a stock was selling for $1.50, the next increment up was $1.625 and the next step down was $1.375. They are now priced down to the penny, so a $1.50 stock can go directly to $1.51 or $1.49.
I'm not entirely sure why he cites this as a bad thing, but I'm assuming that there's some arbitrage opportunity to value investors when dealing with eighths of a dollar (since if a stock was priced at $1.50 but was really worth $1.55, you'd be getting $0.05 of "free" value by buying it).
I'm not entirely sure why he cites this as a bad thing, but I'm assuming that there's some arbitrage opportunity to value investors when dealing with eighths of a dollar (since if a stock was priced at $1.50 but was really worth $1.55, you'd be getting $0.05 of "free" value by buying it).
Taken together with his other points, I think the author is under the impression that it was the "Boiler Room" operations peddling penny stocks that were driving IPOs. Trading in eights was probably good for brokers skimming money from transactions, but I can't see how decimalization can be considered bad for investors.
Don't know if it's in any way the cause of anything related to a decline in IPO, but this spread is what the banks make money on and what enables them to do what they do, effectively a measure of their margin on trades. Going from an eighth to a hundredth just means their margins effectively were reduced, but was probably a result of an increase in volume / trading activity.
I think there is a couple of things going on here, though. Decimalization made stock market-making less profitable for Investment Banks. And the re-regulation of stock analysis prevents banks from using research analysts to tout stocks. By making it worth less to investment banks to invest in research, every customer has to invest more in research. Arguably this isn't too bad a problem - until it comes to smaller stocks, where the knowledge-base of the market is getting hollowed out - and liquidity dries up since no-one who is not in the stock has much incentive to do the initial research.
The same thing happened in High Yield Bonds. The NASD (FINRA) brought in reporting system for bond prices (TRACE) that made trading bonds inherently less profitable for the middle-men (though much more transparent for investors). That meant that there was less incentive for the middle-men to do research, causing researchers to leave to join hedge-funds. So the end-game is a very fragmented market, where if an investor wants to sell a bond, they don't have an audience that's had any consistent commentary on the situation from a 'neutral' middleman.
The same thing happened in High Yield Bonds. The NASD (FINRA) brought in reporting system for bond prices (TRACE) that made trading bonds inherently less profitable for the middle-men (though much more transparent for investors). That meant that there was less incentive for the middle-men to do research, causing researchers to leave to join hedge-funds. So the end-game is a very fragmented market, where if an investor wants to sell a bond, they don't have an audience that's had any consistent commentary on the situation from a 'neutral' middleman.
Back in the day, when a $10 million IPO was too big and you wanted to raise only a million or so one of the places you turned was to the Vancouver Stock Exchange. (It was also the place to lose your shirt or gain a fortune betting on penny stock mining firms).
It's changed hands and is now known as the Canadian Venture Exchange, and is still a great place for sub-$10 million IPO's. It's last IPO was for a mining firm who raised 5.75 million dollars selling shares at 50 cents a pop.
It's changed hands and is now known as the Canadian Venture Exchange, and is still a great place for sub-$10 million IPO's. It's last IPO was for a mining firm who raised 5.75 million dollars selling shares at 50 cents a pop.
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very good article...but I think it's underestimating the culture shift of companies not even considering IPOs in that range
I'm not sure it's possible to disambiguate his point and the culture shift. i.e. perhaps the culture has shifted because of the issues he's described.
How does it make sense to do a $10 million IPO when they are going to spend 20 percent of the proceeds to implement SOX?
There needs to be some change in the security laws to allow small companies to opt out of Sarbanes-Oxley.
There needs to be some change in the security laws to allow small companies to opt out of Sarbanes-Oxley.
The part about small caps being sold and not bought is particularly interesting to me.
Right now I'm working on a stealth project that will address the needs of small cap and private companies wishing to raise cash on equity. We've had amazing feedback from the small number of companies and investors already involved. Think Kickstarter except getting equity instead of cheap plastic trinkets. We'll also have the ability to get someone to call you who can speak knowledgeably to the details of the deal and can connect you with a licensed & regulated professional to handle the execution. $10 million IPOs are very common, look at an exchange like the TSX.V it's filled with small IPOs in the Resource sector. A large part of the logic behind the proposed TSX / LSE merger is to address exactly the concerns of the resource sector and have a single exchange which is dedicated to the resource sector.
We're going to rock the startup finance scene pretty hard. If you're looking to IPO think Canada, not California. Our financial institutions are as rock solid as the Canadian Shield.
http://www.theglobeandmail.com/news/national/toronto/globe-t...
HFT is much less common in Canada, and it's a perfect market to do a small IPO. In the last 20 years Canada has drastically changed it's tax code in relation to corporations. We also don't have Sarbox and other onerous requirements. I'm not an accountant but IIRC the small biz tax rate is something like 11%. A $10 million IPO is never going to make the front page of the NYT but they are definitely out there.
Right now I'm working on a stealth project that will address the needs of small cap and private companies wishing to raise cash on equity. We've had amazing feedback from the small number of companies and investors already involved. Think Kickstarter except getting equity instead of cheap plastic trinkets. We'll also have the ability to get someone to call you who can speak knowledgeably to the details of the deal and can connect you with a licensed & regulated professional to handle the execution. $10 million IPOs are very common, look at an exchange like the TSX.V it's filled with small IPOs in the Resource sector. A large part of the logic behind the proposed TSX / LSE merger is to address exactly the concerns of the resource sector and have a single exchange which is dedicated to the resource sector.
We're going to rock the startup finance scene pretty hard. If you're looking to IPO think Canada, not California. Our financial institutions are as rock solid as the Canadian Shield.
http://www.theglobeandmail.com/news/national/toronto/globe-t...
HFT is much less common in Canada, and it's a perfect market to do a small IPO. In the last 20 years Canada has drastically changed it's tax code in relation to corporations. We also don't have Sarbox and other onerous requirements. I'm not an accountant but IIRC the small biz tax rate is something like 11%. A $10 million IPO is never going to make the front page of the NYT but they are definitely out there.
#1: This is really a consequence of the other factors he cites.
#2: Decimalization made stock trading massively cheaper. When prices were quoted in eighths, the price at which you could sell was 12.5 cents lower than the price at which you could buy. This difference went straight into the pockets of brokers, not investors. It was basically free money.
#3: Internet brokerages. What, you'd rather get on the phone and call someone to make a trade? I love the convenience of E*TRADE and similar platforms.
#4: The growth of prop trading, in and of itself, didn't push out IPOs. It merely filled the void in profits left when IPOs stopped making as much money for the banks.
#5: Keep in mind how research used to be done: banks would effectively promise to write good research on stocks they brought to market. I think it's absurd and insulting to new companies to suggest that no one would buy their stocks unless accompanied by heavily biased "research."
#6: Guess what, shareholders are the owners of the companies. They should have a say in how companies are run. There's a balance between their interests and management's interests, but the author merely asserts that things went to far without providing evidence.
#7: While there's plenty of wealth outside the US, international investors are still able to invest in the US. I don't see why this is a negative for IPOs.
#8: Larger funds: I'll admit that I'm unsure about this criticism. I don't know enough about this area of the market.
#9: Keep in mind that Sarbox was passed to prevent Enron and Worldcom. Its requirements may be onerous, but they're designed to help prevent specific types of fraud that were extremely damaging to the economy. While Sarbox may have reduced IPOs, it also may have reduced the risk of fraud. It's difficult to say.