Our guest blogger today is Dr. Jay Ritter, renowned IPO researcher.
Professor Ritter is the Cordell Professor of Finance at the University of
Florida and has published more than 30 papers regarding equity issuance. Below,
Dr. Ritter updates his previous post on the current IPO market.
2013 saw more initial public offerings (IPOs) in the U.S.
than in any year since 2007, and the financial press has been full of stories
about the booming IPO market.
IPO volume tends to fall in bear markets and rise in bull
markets. In the United States in 1980-2000, an average of 302 operating
companies went public each year. Since then, volume has been much lower.
Indeed, even with the S&P 500 increasing by 30% in 2013, only 156 operating
companies went public last year. The low level of IPO activity compared with
the 1980s and 1990s has frequently been attributed to a changed regulatory
environment, with the Sarbanes-Oxley Act of 2002 being singled out for
increasing the costs of being publicly traded. The Jumpstart Our Business Startups
(JOBS) Act of 2012 reduces some of these burdens, especially for Emerging
Growth Companies, defined as companies with less than $1 billion in annual
revenue that have recently gone public.
In “Where Have All the IPOs Gone?”, which will be published
in the Journal of Financial and
Quantitative Analysis, Xiaohui Gao, Zhongyan Zhu, and I present an
alternative explanation for the prolonged low level of small company IPO
activity that has existed since 2000. We posit that there has been a structural
change whereby getting big fast is more important than it used to be, especially
for technology firms. We argue that organic growth (that is, internal growth)
takes too long for a company with a hot new technology. Rather than going
public and remaining as an independent firm, the company finds that its
value-maximizing strategy is to sell out in a trade sale. The acquiring firm is
willing to pay top dollar because it can create more value by rapidly
integrating the new technology into its existing products, generating greater sales
because it can certify the product with its brand name and use an extant
marketing organization, rather than needing to hire new employees to expand.
People frequently think of an IPO as part of the
life-cycle of a successful firm founded by an entrepreneur, with the IPO being
both a capital-raising event and a “liquidity event” that occurs once a firm
has achieved a critical level of scale. In the 1980s and 1990s in the U.S.,
this framework was very descriptive of actual practice for many entrepreneurial
firms. Since the tech-stock bubble burst in 2000, however, this framework is
increasingly at odds with practice. Instead, venture capitalists have been
operating with a “build to sell” model in which they exit from an investment in
a successful portfolio firm via a trade sale, in which the entrepreneurial firm
sells out to a larger firm in the same or a related industry, rather than
remaining independent. In other words, the traditional life-cycle for a
successful technology change has permanently changed.
