United States: Are Rumors Of The Demise Of The Public Company Greatly Exaggerated?

Last Updated: August 21 2018
Article by Cydney Posner

As you've surely read and heard, there's been a tremendous amount of hand wringing, particularly at the agency and congressional levels, about the steep decline in the number of public companies and IPOs. For example, in congressional testimony in 2017, SEC Chair Jay Clayton expressed concern regarding the decline in the number of public companies, contending that it is Mr. and Ms. 401(k) who bear the cost of this trend because they now have "fewer opportunities...to invest directly in high quality companies." (See this PubCo post.) The topic has also been taken up by various House committees, SEC advisory committees and SEC forums, as well as by securities and industry organizations. (See this PubCo post, this PubCo post and this PubCo post.) However, in this article, a Cambridge professor cries "nonsense": the primary dangers to public company status, such as buyouts by private equity and a recent bias against conducting IPOs, do not pose "an existential threat to the American public company." While there are certainly fewer public companies than in decades past, "the public company remains as crucial a feature of the American economy as it has ever been."

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In his testimony, Clayton attributed much of the decline in the number of IPOs to regulatory overload: "fewer companies are choosing to go public in their growth phase or at all and, consequently and significantly, there are fewer investment opportunities for Main Street investors. It is clear to me that our public capital markets are relatively less attractive to growing businesses than in the past. Based on my review and discussions with Commission staff and others, the reporting, compliance and oversight dynamic between private and public markets appears out of sync. Costs—ranging from direct compliance costs to the consumption of management and employee bandwidth—for public companies, particularly smaller and medium-sized companies, far outstrip those of comparable private companies. Thus, many companies with the choice of going public may be incentivized to stay private or stay private longer."

But a well-armed Senator Elizabeth Warren took Clayton on. In 1996, she said, the dot.com peak, there were 624 IPOs with a deal volume of $36 billion. From 2012 to 2016, there were about half that number of IPOs, but they had a higher average annual deal volume, and in 2014, the deal volume for IPOs was $96 billion, almost three times the deal volume in 1996. That means that, even though there were fewer deals, more money was actually being invested than in 1996. Wasn't that better for investors, she asked? Clayton responded that it was better for investors to be able to invest at earlier stages and to ride the growth curve up rather than to invest in more mature companies. He was concerned that there was more private money taking advantage of the growth curve and that these private investors were profiting more than the later public investors. But Warren again looked to the data, which she said showed that investing in fewer bigger IPOs was better for investors. Investors were pouring more money into IPOs now, and the current crop of IPO companies tended to have more revenue and to perform better in the long run than in the past, she said, which should actually benefit Mr. & Mrs. 401(k). He may fear, she suggested, that something is wrong with the market as a result of the rules and regulations, but, in her view, IPO companies now were more stable and, ultimately, that was better for investors. The SEC's mission, she said, was to watch out for investors. Clayton responded that he understood. (See this PubCo post and this PubCo post.)

The author begins by emphasizing the importance of public companies to the US economy: for example, while only 4,300 of America's 28 million businesses are public companies, they are responsible for half of all business capital spending. In addition, it was among U.S. public companies that serious discussions of corporate governance issues took hold. However, there was a "substantial drop in the public company population from the late 1990s through to the late 2000s and there has not been a meaningful rally in the years since...despite the overall number of firms operating in the U.S. increasing from 4.70 million in 1996 to 5.04 million in 2012 and despite the number of companies listed on stock markets outside the U.S. increasing 28 percent over that same period." Part of that decline, the author asserts, is attributable to the attractiveness of private equity buyouts. In addition, the reluctance of promising and sizeable companies—exemplified by the phenomenon of the "unicorn," which used to be rare, but in 2018, numbered 105—to access the public markets, dating from the dot com bust, has dampened IPO activity.

While excessive regulation has been cited as a major deterrent, the author considers it "doubtful... whether regulation has played a major role in dissuading firms from going public." For example, he argues, the period post-JOBS Act provided significant deregulation, but witnessed only a "very modest" increase in IPO activity. Instead, he argues, the "reticence regarding IPOs has in fact been due primarily to market factors. If a privately held company with promising prospects is producing relatively little cash flow, for the proprietors the possibility of raising capital by selling shares to the public can provide a compelling reason to join the stock market. A desire to provide liquidity for current shareholders can do the same." Now, however, there are a variety of private opportunities for liquidity, such as platforms for secondary trading in private companies. With regard to availability of capital, companies can now "scale up more cheaply" than in the past as a result of the increasingly technology-intensive economy and no longer need to have recourse to the public markets as a result of the ready availability of private capital.

None of these factors, the author asserts, portend the doom for the public company as has been portrayed: "In fact, public-to-private buyouts do not pose any sort of existential threat to the dominance of the public company." Although there was a spike in private equity buyout activity in the mid-2000s, the author points out, it screeched to a halt during the 2008 financial crisis and never regained that same altitude, as private equity firms began to diversify their activities. What's more, the author contends, "[p]rivate equity... is now an afterthought amongst America's largest corporations. Of the 20 private companies with revenue exceeding the 2017 Fortune 500's 200th ranked company only... a grocery retailer that also placed 49th in the Fortune 500...was under private equity control." While "public-to-private buyouts continue to occur, they are not currently transforming the face of American corporate capitalism" as had previously been predicted.

And, even if fewer companies conduct IPOs, they often still end up on the public market, even if indirectly: with regard to "prosperous start-ups, they most often do end up linked to the stock market, albeit quite often through the indirect route of being acquired by a company that is already publicly traded. A by-product is that, while there are fewer public companies than there used to be, those which are listed on the stock market are larger than they were formerly." Accordingly, the author maintains," the economic significance of the public company has not been fundamentally compromised." What this means is that, for a promising start-up, a sale of the company to a large established public company has "has since 2000 grown considerably in popularity in relation to IPOs as an 'exit' mechanism." As a result, "the assets most often end up in the public company realm, albeit by a different route."

Moreover, he predicts, "if a sale to an established company is not forthcoming, regardless of misgivings among the proprietors about going public a combination of the financial and liquidity factors that prompt IPOs will likely tip the balance over time in favour of a public offering. While exit options for shareholders in private companies have improved, the stock market remains the most convenient venue for selling shares. As for raising cash, even the best-resourced unicorn is unlikely to have the financial wherewithal to carry out large scale acquisitions."

In addition, he contends, companies "have been staying private for longer, not forever"; the median age of companies conducting an IPO is 50% higher now than 20 years ago, with the result that "companies moving to the stock market are bigger than used to be the case. This is evidenced by the fact that the decline in annual aggregate IPO proceeds since 2000 has been much less precipitous than the decline in the number of IPOs."

But is it the case that "the decline of the American public company is less precipitous than is widely perceived but is occurring nevertheless"? Not in the author's view. In fact, he contends,

"public companies arguably are currently as important relative to the U.S. economy as they ever have been, if not more so. The relationship can be measured by reference to the ratio of the aggregate market capitalization of publicly traded stocks to Gross Domestic Product (GDP). Due to a stock market rally that began following the 2008 financial crisis, by 2015 the ratio was close to previous all-time highs.... With stock prices having increased markedly since then, the stock market has probably never been bigger in relation to the American economy than it is now."

Although the number of public companies has declined, their market caps are much larger: "In 2017 the market capitalization of listed U.S. companies averaged almost $7 billion, more than 10 times as much on an inflation-adjusted basis as the equivalent figure for 1976." The author recognizes that one result of this trend is that "public investors have less scope to capture the upside with fledgling companies experiencing rapid initial growth and to gain exposure to fast-growing industry segments"—as noted above, a complaint regularly voiced by the SEC Chair Clayton. "Nevertheless," he concludes "the public company continues to dominate the big business landscape in the U.S. and current trends suggest the pattern should endure."

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