Only 9 small companies listed on US exchanges in Q1 2016. Are public markets in trouble?
Way back in 1989 a statement was made by a Harvard Business School professor emeritus that at the time was viewed as controversial, bordering on outlandish:
“The publicly held corporation has outlived its usefulness in many sectors of the economy.”
The professor in question was Michael Jensen who in 1976 co-authored Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, one of the most widely cited economic papers of the last 50 years. Jensen and co-author William Meckling’s paper is considered to have been the foundation for the practice of awarding employees with equity options as part of their remuneration. Jensen’s definitive 1989 statement was all the more radical having been made by one of the most well-known academics of economics and corporate theory in modern times.
More than a quarter of a century later there is evidence to suggest that his bold assertion is coming home to roost. The first quarter of 2016 saw only 9 smallish companies list on US public markets, a remarkably small number. This can be to some extent explained by negative market conditions in the first months of the year meaning conditions for successful IPOs were poor. A further 21 companies cancelled planned IPOs over the same period. However, taken in the wider context, 2016’s IPO-light trend is an, admittedly accentuated, part of a clear pattern of fewer companies opting for public listing. Those that do opt for IPOs are doing so further down the growth line. While the decline in the number of IPOs in the USA is the most noticeable, a similar trend can be observed around the world.
Alternative Finance Usurping Public Markets
While early-2016 has seen jitters over the global economy, particularly the oil price slump, commodities rout and fears over China’s economic growth slowing, corporate America is generally considered to be in rude health. Low IPO activity is not because of a lack of investment cash or a readiness to invest it. Investment levels in new and quickly growing companies has arguably never been higher. These companies are simply increasingly turning to alternative funding options. It is well documented that banks have significantly reigned in their lending to SMEs, so companies are not getting their expansion capital from the traditional lenders.
Alternative finance is the avenue that companies that would have in the past opted for an IPO are turning down to provide the capital they need to fuel their growth. It is no coincidence that not only has the US seen the most noticeable drop off in IPOs recently, it also has the highest rate of alternative financing lending to SMEs at 45% of the market. This compares to 13% of all lending to similarly sized companies in Europe.
The booming VC industry, private equity and developing corporate bond market mean that good young companies have plenty of alternatives to a public listing when it comes to raising capital or providing early-stage investors an opportunity to cash in. Preparing for an IPO often takes up to 2 years, is expensive and onerous and if market conditions are not healthy at the point of the IPO it is often delayed or shelved altogether. Alternative finance options can be accessed much more quickly and easily and mean that companies have less pressure to deliver profits in the short term and can focus on growth.
Have Public Markets Outlived their Usefulness?
There are still good reasons why companies will turn to IPOs: the publicity can raise awareness and legitimise a new company’s reputation, employees and founders have a liquid market for their stock, investors will want to cash out eventually, and so on.
However, the rise of alternative finance does mean that there is not the same need for companies to go to IPO to raise cash, or can wait until they are much more mature businesses before doing so. Jensen’s 1989 statement is still a long way from reaching fruition, but it also has a ring of truth for more companies than ever before.