I just read the Vox.com interview with Marc Andreessen about IPOs and the state of the global financial markets. There are really two parts to the interview: one about IPOs and one a response to Thomas Piketty’s book Capital. I have opinions about the latter topic, but will save those for another day.
However, the former topic strikes a resonant chord with me, so I thought I would put a few thoughts down. The IPO market is something I know a thing or two about. Given the subject of the interview, I thought my response might work as a Tweetstorm (for those of you new to Twitter, that’s a series of related Tweets posted serially.) I found that this approach is more interactive, but also a bit harder to convey all I wanted, hence this post.
I agreed with Andreessen on the generally poor state of the IPO market today. Or more to the point, the burdens that going public now places on small private companies. An IPO is an expensive endeavor – lots of lawyers, accountants and bankers. Much of this burden is induced by regulators, but a lot of today’s IPO practice is a function of the business models of the investment that have grown up in response to those regulations over the past eighty years.
At heart, the IPO process is controlled by the investment banks who underwrite stock market listings. Their position, along with the auditors, is somewhat dependent on regulatory bottlenecks that emerged from the 1929 stock market crash and the emergence of the SEC.
I would argue that much of these practices are now open to change. The banks are confronting a variety of changes to their business models brought about by new technology. But so far, the IPO process has proven immune to technological change. Google tried using its own IPO auction process, but that ended up as a very slim virtualization layer resting on top of the old, underlying architecture. Google could force it on the banks because of its status and success, but it did virtually nothing to change the underlying structure of the industry.
There are several reasons for this, and many of these can be addressed by improved technology. As I have argued in the past, too much of the preparation companies do for IPOs focusses on just getting to the listing. Too often companies forget about what happens the next day, and the following years. Decisions made in the heat of the IPO process have a long-lasting impact on how a now-public company is perceived by the market.
One of the reasons that the banks still have so much influence on the IPO process is that they still employ legions of research analysts. These analysts provide a very effective way for companies to communicate with the Street. (Yes, within the confines of Reg FD.)
The average small cap IP stock starts with at least five research analysts poised to pick up coverage. These analysts help to make sure that newly-public companies retain investor interest even after the bell ringing fades. So Google used its reverse Dutch auction to allocate shares, but the banks still managed that auction. Google and every other company still had to contend with the old system because of the importance of having these analysts on board. Maybe Google could have lived without the coverage, but few other companies can.
The good news is that the research product is something that can be very easily improved by technology. Few companies have tried to do this because there are still a host of regulatory dependencies in place. But I would argue that there is still opportunity for a disruptive start-up to greatly improve on the current industry trend. Isn’t that what start-ups all try to achieve? Take a vertically integrated industry and unbundle it with the help of very cheap computing?
I will have more to say on this. Let me know if you would like to learn more, I have a few ideas kicking around my head.