Laura Rich, Editorial Director of the American business monthly Inc. displays some considerable naivety about the functions of capital markets in an article she wrote about the decline in the number of IPO’s last week, belligerently titled “No possibility of an IPO? Who cares. (sic)”
“A story in the Wall Street Journal today makes a big stink over the steadily dwindling number of initial public offerings by start-up companies” wrote the New York Times columnist on Inc.’s weblog, Fresh Inc. “The numbers are indeed bleak: 2005 saw 41 IPOs by venture-backed start-ups, compared to 67 in 2004 and a booming 250 in 1999, according to data from VentureOne, which tracks that sort of thing … The point is, it's hard to see that things are, really, all that bleak for start-up companies. These days, the money's just not in the public market -- it's the private market where it's all happening.”
It is difficult to believe that qualified business journalists would actually put their names to this kind of crude amateur analysis, for it shows a serious flaw in the comprehension of how private and public capital functions actually work. In the first place, any comparisons between 1999 and today are almost universally set aside by professional analysts today as the bull market of the millennium is hardly a fair benchmark for meaningful quantitive data. Secondly, to suggest that there is no difference whether money remains in private equity or heads towards publicly tradable markets displays a gross misunderstanding of the most basic level macroeconomics.
“Who cares?”
Rich asks her readers rhetorically, “So, sure. The IPO market is not what it was for start-ups. But who really cares? Do you?” Well, for one, I’m sure the U.S. Federal Reserve has more than a passing interest in the performance of the IPO market, as it effects the inflow of fresh capital and companies to the NYSE and the NASDAQ, which in turn effects the prices of government bonds and the parameters for rates at which the government can afford to lend and borrow money, and with the current highs of the national deficit, oil prices and the recent ruminations from Beijing that China will now start to cash-in some of her reserves currently held in U.S. T-Bills in favour of international diversification, the establishment of reliable cash flow channels is hardly a done deal right now.
Then there are the numerous retail brokers such as Charles Schwab and their clients, the private investors, who make up a sizeable proportion of the capital markets. While institutional investors such as venture capital funds benefit from private equity placements, private individuals generally only gain significant exposure to these investment opportunities once they are listed as equities on a stock exchange – indeed, this in one of the key functions of an exchange: that it allows a larger pool of individuals who otherwise cannot gain access to investment opportunities to take part in the shareholding process.
In addition, it is retail investors who often facilitate much faster capital market cash-flow as they create easily-available, liquid secondary and tertiary markets for the sale of equity that institutions have realised a capital gain on: this has the effect of freeing up capital that venture capital funds use to finance further investors.
Here the columnist and Editor really might have thought harder about her postulation. To suggest, as Rich does, that “more entrepreneurs are finding it a seller's market,” and that “(they) are doing just fine” is to naïvely assume that only a primary market is necessary in order to facilitate entrepreneurial and innovative growth in an economy. The principle goes back to the age-old law of supply and demand: if demand at the lowest level does not outstrip supply then capital dries up – in the same way, if there is no “re-sell” IPO market for private equity investments then continued funding of entrepreneurial ventures cannot foreseeabley be sustained. Corporate financing activities such as industry trade purchases and big company mergers, as stated as one of the reasons for the IPO decline by The Wall Street Journal in Rich’ s riposte, is hardly a reliable long-term strategy for continued investment funding as there is a significant limit the possibility of these types of deals without fresh capital to cushion the activity.
And so it seems that despite the fact that Rich and her erstwhile team of amateur economists at Inc might not care that much for the number of IPO’s in the market, the very entrepreneurs who she directs so enthusiastically to the publication’s valuation guide – “Take a look at our Ultimate Valuation Guide to get a sense of all the companies that are cashing in” – might end up caring rather more than it seems.
I think her comment was about the fact that for many start-ups the path to growth/liquidity event is also found in the private market more than several years ago. I don't really think she was after much more than that.
The market for private equity has really grown due to the fact that so much money is now dedicated to that sector.
The IPO market is not dead just not as high flying as it once was.
Posted by: David Neubert | May 30, 2006 at 04:13 AM