Public offerings that serve a wealthy few
A winner-takes-all dynamic means a handful of investors sweep in early on hot start-ups
by: Rana Foroohar   

The US market in public share listings is ailing; over the past two decades, the number of initial offerings has plunged 45 per cent. That is one reason Barack Obama, then president, passed the Jumpstart Our Business Startups Act, which allowed listing companies worth less than $1bn to keep their finances private for longer.

The Trump administration recently loosened those standards to include any company of any size, the idea being that less onerous reporting standards would encourage more public offerings.

Jay Clayton, US Securities and Exchange Commission chair, positioned it as a big win for the little guy. The extent, he said, to which companies are eschewing public markets in the US makes most individual investors unable to benefit from their growth.

It is a laudable goal, not only when viewed through the lens of wealth sharing but also because companies that go public create jobs faster than those that remain private.

Yet the logic of loosening standards to increase the number of companies seeking to list is wrong. It is true that the regulatory burden for public companies has risen, in part because of greater reporting demands following scandals such as Enron and the financial crisis.

But by and large, companies are not eschewing public markets because of what happens during the IPO process, but because of what happens before and after. An increase in private funding sources, looser patent enforcement, added pressure for short-term results and a fraying social safety net that stymies risk-taking have reduced willingness to seek an IPO.

As Steve Case, chief executive of Revolution, a Washington-based venture capital group, and founder of AOL, recently pointed out, “companies used to go public to actually raise operating capital”.

Now the goal of an IPO is all too often for investors to “exit” with as high a valuation as possible. Many sources of private money, from hedge funds and private equity firms to sovereign wealth funds, are eager for a cut of a hot sector. Facebook raised $2.2bn in private equity funding over seven years ahead of its IPO.

Uber has raised five times that as well as more than $3bn in debt funding thanks to low interest rates.

This means that, even as the number of IPOs has decreased, the average size of companies that go public has increased dramatically. This has the effect of keeping more money in private hands: even large asset managers know they may not receive all the shares they want from a hot IPO in a constrained market, so they buy in early, acquiring a stake in the pre-public phase. A winner-takes-all dynamic is created in which a small number of institutional investors get in early on hot new companies, and fewer such companies need to come to market.

Other reasons lie behind the dramatic decline in IPOs, such as weaker patent protection over the past 10 years, which makes it tougher for start-ups to protect their intellectual property and thus garner investment.

Macro issues such as decreasing public spending and a threadbare social security system play a role.

The lack of single payer healthcare, for example, makes it more difficult for Americans to leave their jobs to start companies. A 2008 Harvard study estimated 11m workers were caught in “job lock” because they were dependent on employer-based healthcare.

An increase in student debt, thanks in part to lower state funding of college costs, has held back would-be entrepreneurs. “With that [$1.4tn] student debt burden on their shoulders, many millennials don’t feel empowered to take the risk of striking out on their own,” says David Jolley, Americas growth markets leader at EY, the accounting firm.

What is to be done? In lieu of a debt jubilee or healthcare reform, pushing back against short-term market pressure is a good start. Making share buybacks illegal, for example, as they were before 1982, would be a step in the right direction, as would limiting the amount of performance pay that can be awarded in stock options. These give business leaders major incentives to think more about the short rather than long term.

Chief executives and investors such as Jamie Dimon, Larry Fink and Warren Buffett have spoken out about the need to shift standards of corporate governance so that boards can focus less on “tick the box” legal demands and more on management, strategy and risk evaluation. That would probably require major tort reform. One of the reasons boards spend so much time on such issues is the amount of corporate litigation in the US.

There is lower hanging fruit, namely focusing on the types of businesses in the US that need funding. Most of them are not those that would list but those that are making ends meet via founders’ personal credit cards and loans from community banks, which have been unfairly constrained by Dodd-Frank rules. Community banks represent 13 per cent of banking industry assets but 43 per cent of all small business funding.

If the Trump administration wants to repeal regulation, it would do better to focus efforts, not around making public markets more opaque, but on helping bolster the institutions that encourage start-ups to market in the first place.

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