The market for initial public offerings — particularly among small-caps — is mired in a crisis, Grant Thornton capital-markets consultants contend. The debacle has been caused largely by wrong-footed regulatory and technological moves rather than the downturn in the economy, they say.
“Over the last several years, the IPO market in the United States has practically disappeared,” according to “Market Structure Is Causing the IPO Crisis,” a research paper issued by the accounting firm Tuesday. “While conventional wisdom may say the U.S. IPO market is going through a cyclical downturn exacerbated by the recent credit crisis, many experts are beginning to share the view of a new and much darker reality: The market for underwritten IPOs, given its current structure, is closed to 80% of the companies that need it.”
Citing figures from Dealogic and Capital Markets Advisory, the authors report that from 1991 to 1997, nearly 80% of IPOs were smaller than $50 million. By 2000 the number of IPOs smaller than $50 million had shrunk to 20% of the market. More recently, the first half of 2009 “represents the worst IPO market in 40 years,” according to the report, which adds that “[t]he trend that disfavors small IPOs and small companies has continued.”
Only 12 companies went public in the United States in the first six months of this year, and just 8 of those were U.S. companies, the authors note. The median IPO in the first half of 2009 was worth $135 million. “This contrasts to 20 years ago when it was common for Wall Street to do $10 million IPOs and have them succeed,” according to the report.
The authors contend that the loss of small-cap funding hurts the vitality of large companies as well. “We’ve killed the feeder system to the big leagues,” David Weild, a senior adviser at Grant Thornton Capital Markets and former vice chairman of Nasdaq, tells CFO.com. “You just don’t have major league baseball without kids going to Little League and then people in double A and triple A. They need training, and they need to grow up. And when you’ve got a public market that no longer allows companies to grow up, you have a crisis on your hands of epic proportions.”
In industries like pharmaceuticals, for instance, big companies face the risk of the loss of the cost-effective product pipeline represented by start-ups that bloom into IPOs, according to Weild. “A lot of innovation is acquired,” he notes.
The virtual elimination of underwritten IPOs — public offerings in which investment bankers, for example, at least temporarily have some money at risk in the deal — is hurting small businesses by wiping out a source of funding that represented more than 50% of all IPOs, the authors write. Instead, Weild argues, small-caps are relying on “a lot of desperation finance,” including reverse mergers and the private investments in public entities known as PIPEs. Such deals “tend to be very dilutive transactions” to shareholders. What’s more, they “don’t bring support and research” to companies that need them to grow, he adds.