We need an IPO renaissance
Third in a series. As many readers have pointed out, the IPO drought of the last decade has many causes beyond just decimalization of stock trading. Sarbanes-Oxley has made it significantly more expensive to be a public company than it used to be. Consolidation in the banking and brokerage industries have resulted in fewer specialists and hardly any true investment bankers surviving. The lure of derivatives trading and other rocket science activities on Wall Street have made IPO underwriting look like a staid and prosaic profession, too. Fortunately, people in positions of influence are finally starting to realize that there is no economic future for this country without new public companies.
One requirement of the JOBS Act, passed last April, was that the SEC look at trading decimalization, and especially tick sizes, to see if there has been an effect on small-cap company liquidity. If the SEC decides there is such a negative effect there’s the possibility that they introduce a new minimum tick for smaller companies of perhaps a nickel (up from a penny) to as much as a dime. I believe this would help the IPO industry, but many people disagree.
"It would be ironic that increasing the cost of trading small caps might actually improve their liquidity", says my old friend Darrell Duffie, who teaches finance at the Stanford Graduate School of Business. "This is possible. If there is not enough of a floor of per-trade profit in providing market making services, then market making services will not be provided. Too much competition for low bid-ask spreads could drive out participation. If there is a floor, high enough, then each trade execution would be more expensive, but it will be easier to get execution, possibly promoting more liquidity on net. Note that some exchanges are subsidising order execution as a way of raising liquidity.
"But overall, I don’t think raising the minimum tick size will boost IPOs much. It might improve net liquidity for them at the margin, or it might not. But the major costs and benefits to going public are likely elsewhere, I am guessing. First, it is not as desirable these days to be a public firm. Think of Sarbanes Oxley. Secondly, the source pool, the VC world, is not as vibrant as it was, for a number of other reasons. Finally, the demand for risky assets is down. Volumes of trade of all types (even big stocks) is way down".
Darrell, who is one of my heroes, is largely correct. Increasing tick sizes alone probably won’t be enough to create an IPO renaissance. Two more things are required: 1) more and braver risk capital, and; 2) real competition in the IPO space.
Crowdfunding as described by the JOBS Act may well bring the required capital to bear, though with some significant limitations, namely the present $1 million limit on capital raised per year and the $2,000 annual limit on crowdfund investments for unaccredited investors. But if even 10 million unaccredited investors became involved in crowdfunding (less than 10 percent of American households) and invested an average of only half the $2,000 limit, that would still be $10 billion per year, which is a heck of a lot of startups.
But the Wall Street pros don’t like crowdfunding, seeing it as too little money to be worth the trouble. That may have a lot to do with the fact that Wall Street is so far running the game and of course objects to any changes that might threaten their leadership. In this case I think Wall Street could use a little competition, and following recent outsourcing trends I’d see that competition coming from China, specifically Hong Kong.
Why not Offshoring IPOs?
Finally we find a perfectly proper case for offshoring, in this case IPOs.
Why do American companies go public in America? Sometimes they don’t. When I started this gig in the 1980s a popular dodge for technology companies was to go public on the London Stock Exchange (LSE) because it was cheaper and easier and some of the capital and ownership rules were different.
I recall an e-mail exchange years ago with Borland International founder Philippe Kahn in which he claimed that Borland, as a public company, was prohibited by the SEC from lying in public statements. I pointed out to Kahn (who remains today among my Facebook friends) that his company traded only in London and therefore the SEC had nothing to do with it.
Like London in the 1980s, Hong Kong today has a robust retail investor market where the United States, with its huge institutions, no longer does. You and I simply don’t matter to Wall Street, did you know that?
IPOs in Hong Kong are perhaps a third as expensive in terms of fees as they are in America. And for that matter IPOs are happening frequently over there and only infrequently here.
Hong Kong banks want to make business loans. There’s an intrinsic value placed on public companies in Hong Kong of about $30 million. That is, purely on the basis of being traded on the Hong Kong Stock exchange, a company is assumed to be worth $30 million more than if it wasn’t traded. And while such a premium may exist here as well, in Hong Kong companies can actually borrow money against that assumed equity. Standard Chartered or HSBC -- banks that operate in the USA, too, and won’t loan a dime to entrepreneurs here -- will lend up to $10 million to recent Hong Kong IPO companies even if they aren’t profitable.
Hong Kong feels for IPOs like Netscape, circa 1995.
So I’d like to see Hong Kong reach out to US companies as the same kind of minor leagues of public trading that London was in the 1980s.
Bootstrapping to build a prototype, crowdfunding to build a company, going public in Hong Kong to build production, then eventually coming back to NASDAQ or the NYSE as a larger cap company, that’s the food chain I envision for the next decade.
And it would work.
Now let’s see if the SEC will allow it.