Business

The IPO market is broken — here’s how we fix it

brokenipo

This is a guest post by Mona DeFrawi

The entrepreneurship industry is the economic growth engine of the U.S., and it has been blocked from realizing its potential due to the broken IPO markets. The economy stopped growing when good IPO activity disappeared,  and economic and job growth have been flat or declining ever since.

The timing is no coincidence.

The depressed economic growth of the past decade can be traced directly back to the demise of IPOs, showing signs as early as 1996 with the advent of electronic trading. I have often said that high-frequency trading (HFT) doesn’t support long-term investment potential, and has an eroding effect. There is too much liquidity and not enough stability in shareholder base composition for young IPO companies.

This market-wide phenomenon of valuations detached from fundamentals has created downward pressure on valuations, while dramatically increasing uncertainty and lack of confidence in IPOs.

As a result, companies are either stalling their decision to go public, or they are going public to mismatched valuations and disappointing aftermarket results.

So how did we get into this mess?

The Internet Bubble popped

The Internet Bubble popped in a lot of investors’ faces. No one wants or needs another Pets.com. Let’s not kid ourselves — if the IPO markets were better and could handle the traffic, we could easily see 200 IPOs this year from amazing companies grown over the past 10 years, but backlogged at the starting gate.

While many companies are attempting quiet filings in accordance with the Jobs Act, most are failing to complete their IPOs. 15 years ago, all of these growing technology companies would have gone public easily and successfully.

But the high frequency trading world of the bulge bracket banks and their short-term hedge fund clients — who buy most of the IPO allocations today — aren’t designed for growth companies. Traders need highly volatile pops based on hype, so companies like Facebook are perfect targets for their investing needs.

We need fewer Goliaths, and more David’s

The post-bubble 21st century outlook brought a perception that companies need to be very large to have a successful IPO.

What isn’t understood is that creating a long-term shareholder base counterbalances high frequency trading. Companies should take charge of their stock trading activity pre- and post-IPO.

Your bankers are there to support an excellent transaction, but there isn’t sufficient aftermarket support.

The problem with the large banks

It now takes an average of 10 years to IPO vs. less than 5 years prior to the bubble.

At least 300-500 percent of IPO allocations today trade in the first 48 hours of an IPO. As the markets have gotten worse, venture capitalists have are bringing their IPOs to large banks. There is a false perception that only the large banks can get these deals done.

Large banks clearly state that they are not fiduciaries in their IPO agreements. While intermediary “stop gap” measures, such as late stage secondary cash-outs and M&As are offered, it’s dangerous for them to consider long-term options. The long-term markets will collapse under the pressure to cash out now.

The markets must return to supporting economic growth rather than short-term profit extraction, at which they’ve become quite expert. This is a dead end strategy where the parasite eventually kills the host.

What can we do?

We actually have far more power to change IPO activity than perceived. First we must focus collectively on bringing back healthy, functional IPO markets again.

The traditional IPO process hasn’t worked well in our disrupted markets for over a decade. Yet for the past five years, the nation has been experiencing its biggest-ever backlog of great companies, which have already been incubated and funded, hired hundreds and thousands in high-paying jobs, and have excellent potential.

We are facing an issue of a broken IPO infrastructure, not a broken market cycle.

Companies can easily change their IPO prospects, but must invest in preparation. Banding together as an industry, issuers and investors can swiftly re-align transactional and aftermarket activities to actual performance. While everyone has demanded an improved IPO mechanism that provides an on-ramp and full cycle management of IPOs, few realize that they have power to change it.

It is our duty to revitalize the entrepreneurship and venture industries that are critical to America’s economic and job growth. Changing perceptions and actions always requires a transition, but we can most certainly grow healthy IPO markets again.

Mona DeFrawi believes the IPO process is broken.

Mona DeFrawi’s work with Equidity is focused on U.S. capital formation, economic development and job creation. Devoted for 25+ years to supporting the entrepreneurial companies that contribute most to U.S. economic growth, technological leadership and improving our lives, she has delivered results in fundraising, IPOs, corporate development and investor relations.

Broken IPO image via Shutterstock 


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