The reasons for a stagnating US public equity listings market

This week’s 20th anniversary of Amazon’s initial public offering has thrown into sharp relief the stagnation of the US public equity listings market.

Finger-pointing by some at the regulatory requirements of going public — which can be burdensome and costly for small companies — is now yielding to a discussion about longer-term headwinds such as the ready availability of private funding for young companies and the culture of litigation in the US.

Appeal of private markets

The abundance of private capital has swelled the herd of so-called unicorns, or private companies valued at more than $1bn. With private markets flush with cash, the latest crop of hot tech companies have opted to stay private longer.

“It is going to be a continued theme because of the amount of money coming into the fold from private equity to hedge funds,” says Eric Kim, co-founder of Goodwater, a fund that invests in private deals. “A lot of money is pouring in so companies like Snapchat and Uber can stay private longer. When yields are so low where else do you get alpha?”

While private capital is one factor deflating the IPO market, an increase in the number of venture capital-backed companies opting to sell instead is another factor. According to the research of Jay Ritter, a professor of finance at the University of Florida, during 1990-91, 20 per cent of the exits of successful venture-backed companies were M&A transactions, typically sales to a larger company in the same industry, and 80 per cent were IPOs. By 1998-2000, 60 per cent were sales and for 2001-16 that share jumped to about 90 per cent.

Investors risk losing out

The Amazon anniversary is not just drawing attention to the dearth of US IPOs. The best performing IPO in the US since 1995 — only highlights concerns that future retirees who rely on investments in the stock market are missing out on similar opportunities as companies stay private for longer.

Although large mutual funds in recent years have begun investing in companies while they are private and pension funds have exposure to venture capital, when that is put into a fund or funds it represents typically a small portion of portfolios.

“You read about Fidelity and other major asset managers taking significant stakes in private companies like Uber,” says John Gulliver, executive director of research at the Committee on Capital Markets Regulation, a policy group. “It may be true in aggregate, but it is not true in terms of portfolio exposure for the individual investor.”

Legal deterrent

Some point to the threat public companies face from class-action lawsuits as another factor diminishing the appeal of the IPO process. Allowing shareholders to choose whether they want securities class actions is “the real low hanging fruit,” in a quest to increase the volume of IPOs, says Mr Gulliver. The committee argues that these impose costs on companies, hurt stocks prices, but fail to deter wrongdoing or compensate investors. Instead, they want regulators to pave the way for companies to use individual arbitration instead, which is typically a shorter and simpler process for a company as well as less expensive.

“We also need to think about how [regulators] can target the individuals who actually commit wrongdoing,” Mr Gulliver says, rather than penalising shareholders that suffer the consequences of settlement costs.