The Changing DNA of IPOs
4 Trends Behind Today's Smaller IPO Landscape.
Over the past 20-plus years – a period of historic market expansion overall – a curious thing happened to the IPO landscape: it shrank. The number of companies going public has been on the decline, with the average 528 IPOs conducted each year between 1992 and 2000 dwindling to just 135 between 2001 and 2014.
So, what’s behind this dramatic shift? Our experts offer insight into a confluence of industry events and market factors that, together, have altered the DNA of IPOs.
Source: Dealogic, Data as of 02/01/16, Excludes IPOs for BDCs, CEFs, MLPs, REITs, and SPACs, excludes IPOs raising less than $5mm.
Why fewer IPOs?
1. The rise of private capital
One reason for the shrinking of the IPO landscape and, perhaps, specifically for the reduction in the number of smaller deals, is an increase in the availability of private capital.
“Since the tech bust, there has been a proliferation of growth equity investors offering private funding to companies, whereas previously an IPO was an entrepreneur’s only option to raise capital on that scale,” says Sean Wolf, an associate with Raymond James Equity Capital Markets.
Venture capital firms, whose former domain was largely limited to technology and biotech firms, have branched out to nearly all industries and grown in number. The accessibility of this kind of capital means companies are waiting longer to go public and when – and if – they do, they’re at a much more mature phase of the business life cycle, which has likely also contributed to the rise in overall deal size.
2. Increased regulation
Regulation has played a role in setting the barrier of entry higher for companies looking to go public. Over time, growing regulatory costs combined with increasing IPO professional services fees have priced many small-cap companies out, leading them to delay offerings or forego them altogether. For example, the Sarbanes-Oxley Act of 2002, which required public companies to establish and report on internal controls, among other obligations, has led some firms otherwise capable of an IPO to avoid one.
3. Buyers want liquidity
Before 1999, the majority of IPOs were done for emerging companies and deals below the $50-million mark were commonplace. In fact, smaller deals were the norm. “The first deal I ever worked on was a $16 million IPO,” says Mark Lamarre, managing director of Technology and Health Care Equity Capital Markets at Raymond James. “Those small-sized IPOs just don't happen frequently any more. Bigger institutions want to invest in bigger offerings because the trading liquidity is there.”
Today, IPOs regularly top $100 million, and that has shifted the entire IPO ecosystem. In the current climate, investors accustomed to larger deal sizes shy away from sub-$50-million offerings. And that has made these deals too small to “move the needle” on performance for many investors and, as such, not worth the implicit cost.
The U.S. stock markets converted to decimalization – a system in which stock prices are quoted using decimals instead of fractions – in 2001 to align with international standards. This move has led to tighter spreads. While good for investors, the dramatic reduction in the size of spreads has made it more difficult for investment banks to make money trading stocks. Thus, making them less likely to underwrite smaller IPOs and making it harder for small-cap companies to attract high quality underwriters.
But even in a smaller landscape populated largely by bigger deals, there’s good news for small-cap IPOs. Despite the long-term trend, small-cap has grown as a percentage of the total IPO market over the past three years. There are a couple of factors to thank for that:
- The JOBS act, which eased some of the burdens of the IPO process by loosening restrictions on capital raising and giving more legitimacy to crowd funding
- The growing number of Life Sciences IPOs, which traditionally are smaller.