Venture capital may be flavour of the month, but there is still a place for stock market launches, as BRENDAN FILIPOVSKI reports
ARE THE halcyon days of US tech IPOs returning? Investors are salivating at the prospect of several large tech IPOs this year, including Uber, Lyft, Pinterest, Slack, and Palanthir.
With the Dropbox, Spotify, and Eventbrite IPOs of last year, one could be forgiven for believing that IPOs have returned to rude health. While the IPO numbers are not in the stratosphere of the 1999-2000 tech bubble, talk of unicorns, fin-tech, and block-chain abound. The numbers, however, do not match the hype. Tech companies are shunning IPOs, or at least delaying them to much later in their development. So where are all those baby unicorns getting their hay?
The 1999-2000 tech bubble marked the peak of tech IPOs in the US (chart 1). Internet companies were market darlings, and every second listing was for a company with a dot-com at the end of its name. Companies like Infoseek, Homegrocer and theglobe.com all posted massive first-day gains — but have since disappeared.
After the bubble burst, tech IPOs fell dramatically and have remained at a new lower steady-state. There were more tech IPOs in 1999 (272) than there was in all the years between 2001 and 2018 (221) (IPOs with a listing price of 5 USD or greater).
The decline in tech IPOs has not come about because markets lost their appetite for tech stocks. Markets certainly sobered-up after the bubble burst, and started to reapply a healthier level of scrutiny to tech companies, but any loss of appetite has been rectified with the successes of Amazon, Facebook, Google and, more recently, Roku, Snap, Dropbox, Spotify, and others. In fact, investor demand for tech IPOs has probably now outstripped supply. Tech firms no longer rush to list; instead they have shunned IPOs for other sources of finance.
Tech companies have shunned IPOs because speed has become king. Unlike manufacturing companies that need to build factories, tech companies can upscale fast, in virtual space. The cost of producing more software or adding another user to a mobile phone app is often close to zero. Tech companies need to move fast so they can stay ahead of competitors, and IPOs are just too slow. It is quicker to develop a tech company to a point where it can be sold to a bigger company than to grow a company organically and then meet all the requirements to publicly list it.
Strengthening this preference for buy-outs over IPOs is the elevation in status of the serial tech entrepreneur. Back in the 1990s and 2000s, every kid wanted to be the coder that started in the garage and rode their own company to an IPO and world domination. The greater speed to the point of scaling and the ability to exit a company at or soon after buy-out — with handsome rewards — has meant that lightning does not have to strike just once. A new breed of entrepreneurs aims to hurl multiple lightning bolts to the ground; champions of this approach include Elon Musk (Zip2, Paypal, Tesla, and SpaceX), Jack Dorsey (Twitter and Square), and Jonah Peretti (Huffington Post and Buzzfeed).
Tech companies have also shunned IPOs because they do not like the extra responsibilities that come with publicly listed companies. The Sarbanes-Oxley Act of 2002 greatly increased general regulation for public companies. Disclosure requirements force tech companies to show their hand when they would prefer secrecy. The increased burden of public listing has also given rise to a trend of tech firms de-listing. Tech companies do not like disclosure requirements. Research and development are typically key to the future competitive advantage of a tech company.
Listing requirements requires expensive lawyers. Execution of an IPO requires investment bankers, who typically take a percentage of the capital raised as an underwriting fee. The cost of IPOs has pushed tech companies to use cheaper forms of capital.
In contrast to IPOs, venture capital has become easier for tech companies to access. While the burden and costs of public listing have grown, venture capital has become more flexible. The National Securities Markets Improvement Act of 1996 made it much easier for private firms to sell shares in their company. In 2012, the maximum number of allowable investors in large private companies was increased from 500 to 2000.
The amount of venture capital funds available has also increased making venture capital cheaper and more available to tech companies. Tech companies are not as reliant on IPOs for capital as they once were. In 2018, venture capital firms invested around $274bn in companies. This type of investment in tech companies has become so popular that many of the world’s largest traditional companies have started venture capital funds — Johnson and Johnson, General Electric, Time Warner, and even the Campbell Soup Company. Uber and companies like it have had multiple rounds of hundreds of millions of dollars in venture capital funding — long before an IPO was deemed necessary or desirable.
Venture capitalists, however, are being forced to enhance their offering. A recent report in The New York Times by Erin Griffith suggests that a small number of start-ups are starting to shun venture capital because of their aggressive approach in managing and scaling start-ups. One size does not fit all. The article says that some investors are now offering revenue or profit-based loans to start-ups instead of taking a traditional VC approach. Watch this space.
The upcoming IPOs of Uber, Lyft, Pinterest, and Slack show that IPOs are still important to tech companies, despite being eclipsed by venture capital. Public excitement also shows that IPOs are still important to the average investor. Despite this new world of exchange traded funds in 99 flavours, public access to venture capital funds and their investments remains limited.
IPOs of tech companies have become more important to the public — at the same rate as their numbers have decreased. IPOs are worth championing, even if for reasons of equity alone. With the promise of ever-increasing technological disruption, the public needs access to the giant tech companies of tomorrow. They cannot just be the domain of the super-rich.
