Revamping the US IPO Markets & the NCVA's Two Big Blind Spots
The USA desperately needs to repair our growth IPO market. Our ability to efficiently deliver capital to innovative companies has been the heart of our economic leadership.
Issue 1 is paying for liquidity. You can’t rebuild the IPO market without reliable liquidity. Reliable liquidity was provided in the 80’s and 90’s by growth focused investment banking boutiques and they were compensated through trading revenues based on spreads. Unfortunately, no one understands how to put a price on liquidity in growth focused equity markets – not the NVCA, not the SEC, not Fidelity, not the collective finance faculty of Wharton, Chicago and Harvard. During the internet bubble, the supply of public liquidity appeared infinite and the price inevitably moved to zero as spreads collapsed.
Not only did spreads collapse, but it became criminal for the Putnam’s of the world to pay $0.25 per share to trade with a full-service rain-or-shine I-bank when they could pay $0.05 per share to a no-service fair-weather ECN. Without significant trading revenues, the 4 Horseman packed up their research analysts and market makers and rode off into the sunset.
I believe the sentiment at the time was “good riddance.” For a while, it seemed that there was enough liquidity to get by from day traders, ecn’s, and dark pools. But when the economic environment turned choppy, we saw the impact of losing substantial institutions whose business model was dedicated to smooth functioning markets. Institutions that had been trusted to the bridge the gaps in liquidity that can cause a run a stock (bank).
For a functioning IPO market that supports growth companies with all their natural volatility we need trusted institutions that provide liquidity both directly (market making) and indirectly (trusted research). No one can arithmetically answer the question “what is the right NASDAQ spread to compensate a full service I-Bank for nurturing young volatile public companies?” But the dialog around a healthy IPO market has to start with a recognition of the need for liquidity providers and a willingness to foot the bill. Who needs to be in the room to address this fundamental issue – the SEC, NASD, NASDAQ, NYSE, Bill Donaldson, Sandy Robertson, Ken Pasternak and Tom Weisel would be a good start.
Issue 2 is rebuilding the trust that attracts investors. – You can’t rebuild the IPO market for young rapidly changing growth companies without more trust in the system and the IPO product. Sustainability requires trust and trust requires quality standards. We “blew it” in the internet bubble – just as a new universe of individual investors was entering and expanding the IPO market, diligence and research standards fell apart. This is an old story, but an important one to embrace.
Rebuilding the IPO market to help VC’s exit an oversupply of weak companies is a recipe for failure – again. As a former Robertson Stephens partner, it is ironically pleasant to hear VC’s extol the virtues of I-banking boutiques and healthy collaboration between research and banking. The fact that the growth focused banks got fat and sloppy during the internet bubble is well documented – the 4 Horseman went from being the best source for new investment ideas to the target of litigation.
Of course, growth focused banks were not the only ones who got fat and sloppy during the internet bubble. VC’s enjoyed the same tailwind and used it to grow their capital under management over 1000%. But, the VC business has one characteristic that dramatically separates it from I-banking – they have “10 year” funds that guarantee their revenues. The 4 Horsemen got fat and sloppy in the bubble – and were history by 2002. In contrast, the VC industry has been able to invest like it was 1999 for 10 years – which brings us to 2009. Pushing open the IPO market is not the solution for a surplus of mediocre VC backed tech and biotech companies.
We should applaud the NVCA for taking initiative and all Americans should fully support policies that rebuild the IPO machine. But, any policy discussion must embrace the need for high quality standards and recognize the potential negative implications of the current overhang Venture backed companies two blind spots.
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