April 7, 2017    7 minute read

IPOs: The Undersubscribed Option

Panaceum or Burden?    April 7, 2017    7 minute read

IPOs: The Undersubscribed Option

On March 3rd this year, Snap Inc. entered the public markets and ended a long drought of tech IPOs. In the US specifically, volumes and proceeds from tech IPO’s relative to 2015 were down 30% and 79%, respectively. The decline resembles that of the US IPO market where 2016 volumes and proceeds relative to 2015 have fallen 36% and 37%, respectively. In a recent talk with the Senate, Jay Clayton (Trump’s nominee to run the SEC), stated that:

“In recent years, our markets have faced growing competition aboard…More significantly, it is clear that our public capital markets are less attractive to business than in the past.”

He cited regulation as one of the primary factors. Regulation is seen as an easy culprit. The usual suspects include the Sarbanes-Oxley Act, the Regulation Fair Disclosure, the Dodd-Frank Act and the Volcker Rule. Taking this perspective, however, would be a wrong one. The decline in the US IPO market has long been present.

In the US, listings fell by roughly 50% in the US from 1996 through to 2016.  There has been a growing systemic unpopularity for IPOs in the US and believing that curbing or mitigating regulation would reverse the trend is somewhat of a narrow perspective.

The Burden of Going Public

The regulations quoted above are burdensome by being both tedious and costly. These are however one of many costs associated with going and remaining a public company. The costs associated with a company going public can be broken down into both fixed and variable. Variable costs include underwriting discounts. The underwriting discount (also known as the gross spread) is a function of the money raised in the IPO. An example this is if the firm raises $100m and the gross spread is set at 7%, the underwriting discount is $7m. The fixed costs include items such as; listing fees, printing fees, legal fees.

In a survey done by Cassady Schiller, the costs excluding the underwriter discount for an entity to enter public markets in 2016 were on average $3.9m. Furthermore, there are costs associated with remaining listed. One primary cost is the requirement of quarterly and annual reports. These are required to be audited. In a survey done by the Financial Executives Research Foundation, found that:

“Audit fees increased by a median of 3.2% in 2015… found companies paid an average of $1.8 million.”

The rising costs for companies to be listed have meant that companies are now delaying their entry into public markets, with only larger entities managing to handle the costs associated with the listing. The median age of companies doing an IPO increased by 37% from 7.8 years old from 1976 through to 1996, to 10.7 years old from 1996 through to 2016.

The companies that are listing older in age are more mature and larger in market capitalisation. The trend can be seen when looking at IPO’s of previous tech giants. Amazon, Google and Facebook went public in 1997, 2004 and 2012, respectively. Their market capitalisations at IPO price were $625m, $28.761bn and $168.72bn, respectively.

Likewise, the positive sloping trend can also be seen in the length of time since founding, that these entities went public. Amazon went public after three years, Google after six years and Facebook after eight years. A further indication of this trend is evident with the IPO of Alibaba in 2014. Alibaba went public with a market capitalisation of $168.72 billion went public after 15 years since initial founding.

Private Markets

The rising costs causing a reduction in net benefits associated with entering public markets is only one variable in explaining the downtrend. Another factor is the growth of private markets. With more robust private markets and debt financing, the need to go public is reduced. Previously, companies needed to go public to raise funds to expand. Dealing with the hefty costs and regular public disclosures were necessary evils. Now companies have access to large volumes of capital from private markets. In Bain & Company’s Global Private Equity Report in 2016, they highlight that;

“Since 2013, Private Equity funds raised $500 billion annually worldwide, and un-invested dry powder today stands at a record $1.3 trillion.”

Globalisation has also played a major factor in the growth of this industry by expanding the audience to which companies can advertise themselves to. The increased accessibility to the internet has not only made globalisation far more perceptible but also increased the transparency in private markets, further compounding its growth. The expansion has meant companies like Uber can raise vast sums funding without needing to go public. Uber has gone through 15 separate rounds of fundraising since August 2009. The investors range from Saudi Arabia’s Sovereign Wealth Fund to private-wealth customers at banks. Since their last fundraising round in July 2016, Uber has now totalled over $11bn in funding and has a valuation of over $60bn.

The Jumpstart Our Business Startups (JOBS) Act has also allowed companies to stay private longer. The Act allowed companies to test the waters and ease their way into becoming public companies. The act also raised the number of permitted shareholders before the financial information is required to be reported by a start-up from 2000 to 500. The result was that companies could raise more private capital and remain private longer.


The governance structure at private companies is usually constructed on what the founders and investors agree upon. Private companies are incentivised to establish an effective governance structure given both the necessity of an exit strategy and attracting investors. On the other hand, the governance structures of public companies are influenced by many factors including; shareholder-protection rights dictated by SEC rules, stock exchange listing requirements and public-market tradition. The rules and regulations such as these and other including, Sarbanes-Oxley Act shift the balance of power away from entrepreneurs, leading to less enthusiasm to list.

Whilst going public enables you to spread the risk of the company across a range of shareholders, it also opens the possibility of losing control and influence in the future direction of the company. Companies are subject to constant scrutiny and appeasement of shareholder expectations. One common notion is that by remaining private; companies can often focus more on long-term targets rather than meeting short-term expectations to maintain share prices.


For the individual investor, the selection of stocks from which to invest in equities has declined. From 1976 through to 1996, more than 2,500 new companies were newly listed on either the New York Stock Exchange or NASDAQ. The following two decades saw the population of listed companies fall by 3,650. While at the end of 2016 the US equity market held 53% of the global stock market, the population of stocks are shrinking.

Previously, the purpose of companies listing on a stock exchange was to raise capital. This allowed the individual investor to participate in the growth of these entities. This can be seen when comparing the total returns of the three previously mentioned entities, Amazon, Google and Facebook. From their initial IPO to the 31st of December 2016 the total returns of the entities are 565, 20 and 3.7 times their money, respectively. By delaying their initial listing, companies are now more mature meaning it is the private market investors such as the large institutions that are benefiting from growth phase of these companies.

The next phase of the IPO market could resemble companies following that of Snap Inc., where they issued non-voting shares. If it means that companies are more willing to go public if shareholders relinquish more rights and control than that might just be a sacrifice shareholders are going to have to take. Ultimately, it is the individual investor who loses out.

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