The Crisis In Entrepreneurial Finance: The Death of “Liquidity Event” IPOs
By Clark S. Judge: managing director, White House Writers Group, Inc.; chairman, Pacific Research Institute
Why are the American economy and the number of American jobs growing so slowly? A few days ago, I stumbled on one answer. And for once, it didn’t have to do – or, at least, much to do — with economy’s mismanagement by the current administration.
As part of a swing through California, I spent a morning with one of Silicon Valley’s most experienced and impressive serial entrepreneurs. I’ve lost track of all the ventures he has started or captained. But from twenty years in the tech community, he has gained unparalleled insight into the entrepreneurial ecosystem in our time.
That ecosystem has fundamentally changed in recent years, he told me. The reason is how new ventures are financed.
It used to be, he told me, that there was a clear path to starting and, in successive stages, financing the growth of an enterprise. After a few rounds of angel funding, you’d graduate to venture funding and then you’d go public. IPOs are where things have changed, he told me.
A decade ago, an IPO was a mid-stage “liquidity event,” as he put it. Your reason for going public was not just – or even not at all – so your early investors could get their money out. It was to raise money beyond the amounts available from the venture community to fund the next stage of growth.
Today, he told me, the “liquidity” IPO is all but dead. To go public, companies must be much larger than in the ‘80s and ’90s and they must have significantly greater growth potential. It is arguable, he said, that we used to go public too soon. Now they come too late, if at all. The preferred next step has become selling to a larger company.
So why the change, I asked. He answered it was changes in policy from Washington, but not Dodd-Frank (though he said the legislation played an aggravating role) or Obamcare. It was the 2002 Sarbanes-Oxley Act. Sarbox, as it is often called, injected massive costs into maintaining a public company. It also created restrictions on boards and management that may be appropriate for an ExxonMobil but are impossible for a still-developing young company.
Here is why the death of the “liquidity event” IPO matters to the rest of us. Researchers have found that a path to ever-larger funding was critical to the explosive job creation the country experienced in the 1980s and 1990s. True, the job growth occurred – and could only have occurred – in the context of a tremendous growth in the number of start-ups. But job creating was concentrated in just two percent of those new enterprises – ultra-rapidly growing firms that the leading researcher of the topic has called “gazelles.” It was the gazelles – or, rather, candidates for gazelle status — that needed those fundraising IPOs.
And it was, in large part because the money for their growth could be so readily and inexpensively raised that the United States created so many millions of jobs just as the baby boomers were entering the job market. In the 1980s and 90s, demographics could have produced a crisis of unemployment and under-employment such as we are experiencing today. Instead, the United States went through a time of labor shortages. Incomes rose. Attracted by the robust job market, immigration boomed. Americans at all levels prospered and, as a range of recent research has shown, they prospered in roughly equal proportions to one another with income disparities NOT increasing (see, for example, http://tinyurl.com/kzxc5hw <http://tinyurl.com/kzxc5hw> and http://tinyurl.com/bps9qsn<http://tinyurl.com/bps9qsn> ).
My source is, as I said, prominent in the tech community. But the dynamics of entrepreneurial growth that he described are universal. They apply to all industry sectors. Eleven years ago, Congress all but closed IPOs out of their role in entrepreneurial finance. This is one reason we are having such slow growth today.