The Myth of IPO Fever

Let’s face it. Exciting growth is a rare sighting in the stock market these days.

It’s not even part of the package you get with tech companies that have been very successful in the past. (If you want to know why, take a look at this recent article of mine.)

Nowadays, almost all the most exciting growth comes from young, innovative companies using new business models and solving huge problems.

The fly in the ointment? They’re all hanging out in the private sandlot of venture capitalists and angel investors.

That’s why the uptick we’ve seen in IPOs during the last few months was met with so much enthusiasm. This blurb from Fortune was typical…

After years of avoiding the public markets, Silicon Valley suddenly has IPO fever. Snap’s successful debut, paired with solid early performances from MuleSoft and Okta, has investors – both the Wall Street kind and the Sand Hill Road kind – making squee sounds of excitement.

Fortune went on to say that “the IPO pipeline for venture-backed tech companies looks healthier than it has in years.”

Insiders gave rosy forecasts. Goodwin Procter, the company that helped prepare the recent IPOs of Okta and Snap, said, “There’s still a nice pipeline of companies that will come out.”

And Bob McCooey, senior vice president of Nasdaq’s Listing Services, said, “This post-Labor Day to Thanksgiving window could be one of the busiest that I’ve seen in the decade that I’ve been here.”

Winter Has Come

These declarations have a whiff of desperation. The Nasdaq (and other public exchanges) has lost out on huge fees. Other major losers include…

  • The big banks. They lose out on millions of dollars in underwriting fees.
  • Pre-IPO investors. They can’t liquidate their private shares.
  • Founders and early employees. They hold share options or warrants that would make them rich, but they can’t cash out.

An IPO revival would be great news for them. Unfortunately, it’s not going to happen.

Admittedly, there’s been a little surge, and we may get another mini-wave later this year. But that’d be like declaring it’s summer in the middle of January because of a couple of warmer-than-usual days.

Winter has come to IPOs. And it’s here to stay. The trend is unmistakably downhill…

As you can see, IPOs have been declining for a decade. Last year, only 111 went public. That’s a stark contrast to 1996, when 624 companies IPO’d.

Not even the current strong bull market has been able to reverse it.

The Biggest Losers

I haven’t even mentioned the biggest losers – the Jane and Joe investors who put a ton of their savings into the public stock markets.

The IPO winter has not been kind to public stocks. As the flow of IPOs has dried up, public exchange-listed stocks have shown all the classic symptoms of a dying breed…

  • Shrunken population: It’s in an irreversible decline. Of the 7,500 public companies trading not that long ago, nearly half of them – some 3,400 – are now out of business.
  • Reduced vitality and growth: The past decade has seen uninspiring returns – just 4.5% a year.
  • Sense of bewilderment: I could have just as easily called it denial. Dying breeds usually don’t know what hit them. Such is the case here.

Many chalk up public stock underperformance to increasingly expensive stock prices. They’re in the Jack Bogle camp. The Vanguard founder puts future returns at 4%. It’s 2.5% when taking inflation into account.

Staying Private

The problem with this explanation? When prices eventually do go down, the drivers of the IPO winter are likely to still be there. Those drivers include…

  • The Sarbanes-Oxley Act (SOX). We’ve talked a lot about the unintended consequences of SOX (here and here). It has heaped a lot of expensive and time-consuming requirements onto companies aspiring to go public.
  • Startups living quarter to quarter. I’ve met scores of founders who dread having to keep Wall Street bean counters happy every quarter. With this on top of SOX, founders think, why go public unless they have to?
  • Inflated valuations. Hundreds of fast-growing late-stage companies have won rich valuations. They don’t want to risk launching an IPO at a lower valuation (a “down” IPO). So they put it off.
  • Startups sitting on plenty of cash. What easy money combined with increasing investor interest has wrought. Most late-stage high-flying startups have raised plenty of cash. They don’t need to go public to raise more.

What’s an Investor to Do?

Only one solution makes sense.

Startup investing is the only place where hypergrowth is NOT a pleasant surprise, but an expected marker. Invest in the private shares of private companies raising money outside the public markets.

Recent government-issued rules now make it possible for EVERYBODY to invest in startups.

The government did its part. And now we’re doing ours.

We understand that many people don’t have the time to do the kind of serious research into a startup that needs to be done before an investment decision is reached.

To be left in the lurch because of that… NOT investing in high-upside equity when the gates to this kind of investing have been unlocked and opened by – can you believe it – none other than the government itself.

What a shame that would be.

So that’s our promise to members of our First Stage Investor service. We do the vetting so they can make investments based on expert advice.

It makes a lot more sense than waiting for “IPO fever” to revitalize the public markets.

Invest early and well,

Andy Gordon
Founder, Early Investing