Back to the IPO Doldrums?

After initial public offerings (IPOs) had a robust 2014, it looks like 2015 has been a bit quieter, according to a recent article in the Wall Street Journal.  But not because companies aren’t growing.  The companies are doing fine; they’re just not going public, opting instead to court buyers and quietly sell themselves.  The trend away from IPOs isn’t a new one; it’s been in the works at least since the late 1990s.  While some celebrated 2014 as a return to vibrant public capital markets in the United States, it may be that the year was simply an anomaly. 

The question, of course, is whether this trend is a bad one.  The answer depends on the cause.  For any one company, the decision to sell may be exactly the right one, no matter what the IPO environment.  Some business models may work better as a business line within a larger organization, or the two companies may be able to exploit synergies and create a new company that is greater than the sum of its parts.  But it’s not clear that these motives are what’s driving the current trend. 

The Journal found that at least 18 companies that had filed papers with the SEC abandoned their IPOs due to acquisition.  This suggests that companies that are otherwise interested in going public nonetheless find acquisition the more attractive option.  The process of going public and maintaining good standing as a public company has been increasingly difficult (and expensive) over the last several years, due to increasing the regulatory requirements imposed by Sarbanes-Oxley and other follow-on regulation.  Increased regulatory compliance imposes both direct and indirect costs.  Direct costs include the expense of paying internal and external experts (mostly accountants and lawyers) to provide guidance and prepare disclosures.  Indirect costs include the risk of facing either litigation or an enforcement action (or both) due to a misstep in the compliance process. 

Another reason companies may forgo the IPO is that the private capital markets have become roomier.  One of the key drivers behind going public has always been the need to access cash, and lots of it.  Recent changes in the securities laws have made it easier for a company to stay private even while amassing shareholders, and to reach out to potential investors.  Even with these changes, however, companies must still register with the SEC (i.e., go public) when they have more than $10 million in assets and more than a certain number of shareholders.  And for a growing company, $10 million is not really that much money.  Which means that at a certain point, rapidly growing companies will face a choice: artificially cap growth to stay below the $10 million ceiling and shareholder limit; go public; or merge. 

Of course, a merger is not the same as an IPO.  A large number of mergers without complementary growth in new companies tends to result in consolidation and decreased competition.  Decreased competition tends to result in decreased innovation.  Also, in a merger where one or both of the parties is privately held, valuation can be more art than science (with a dose of conjecture as well).  Publicly traded securities benefit from the market’s price discovery mechanism.  While the securities of non-public companies can be traded, these trades are subject to a number of restrictions and lack the transparency that trading on a public exchange provides.

A company that sells itself provides an exit for its early investors and a liquidity event for its employee shareholders.  It is not, however, a true substitute for raising capital.  To the extent that a company’s management and owners would prefer to keep building rather than sell their creation, they should not be stopped because the regulatory burden of becoming a public company is too daunting.