29 April 2009

A "4-Pillar Plan" to Fix the IPO Market

Dixon Doll and the National Venture Capital Association have put together a "4-Pillar Plan" to restore liquidity to the IPO market (see bottom of this post for the link).

It's an interesting approach...the "4 Pillars" include both public and private initiatives, and center on: i) regulation; ii) tax incentives; iii) enhanced liquidity paths; and iv) ecosystem partners (i.e., VC firms, law firms, I-banks, etc.).

Why does it matter?

Because the increasingly-tight IPO market is perhaps the major bottleneck constraining the entrepreneurial funding cycle...

In other words, without a healthy outlet for early-stage investments, VCs and other funding sources are more or less limited to the M&A market to achieve returns; yet there exists only a finite number of buyers in any given industry.

It wasn't always so. Most people will recall the "gold rush" days of the late 1990's, when now-defunct I-banks like Montgomery, Robertson Stephens, Hambrecht & Quist, and Alex Brown cranked out the IPOs at an feverish pace. Those were heady times, with newly-public companies rising 3-fold (and often more) on their first day of trading.

Heady times, but not healthy. The quality of the companies was often abysmal-- little more than a business plan and a catchy name, and the claim of being a future "category killer" in some niche within the nascent Internet space.

Indeed, I worked at an investment bank during that period, and I will admit that quite a few of the companies were taken public mainly on the strength of a charasmatic CEO and a slick roadshow pitch. Other problems were systemic throughout the financial system: research was tied to I-banking (meaning supposedly objective analysts effectively became "cheerleaders" for the firm's IPOs), and 'flipping' and 'spinning' (the practice of giving executives shares in hot IPOs in exchange for I-banking business) were commonplace. A lot of investors-- especially the numerous and vocal main street types-- lost a lot of money.

But the remedy may have been worse than the ailment. New regulation such as Sarbanes-Oxley made it increasingly difficult and expensive to go public. In fact, in the NVCA presentation below, 'Compliance Requirements' are cited as the top barrier to an IPO. Stronger 'Chinese walls' between research and I-banking were erected (which I believe to be generally a good thing), but it means smaller companies have a harder time getting analyst coverage, and their stock prices languish.

The end result is that there is a huge void in the market for small and mid-sized IPOs. This undoubtedly causes later-stage VCs to be more cautious, and the effect certainly filters down the investing food chain-- affecting the early stage innovators who are at the core economic growth.

So does the NVCA presentation hold the solution? Probably not, but it's an important evolution of the dialogue. I particularly like the pro-growth taxation changes, which would both encourage investment in young IPO companies AND encourage stable, long-term holding periods (thus helping to reduce the 'flipping' and rampant speculation of the previous bubble).

I like the people involved in this too. Interestingly, I've pitched (with clients, as interim CFO) to Doll Capital Management a number of times, and found them to be solid folks. In addition, my good friend and colleague Brita, who worked with me for many years at VentureArchetypes, is now part of InsideVenture (one of their suggested remedies for 'enhanced liquidity'.)

Overall it is a good start toward loosening the IPO bottleneck in a restrained, conservative manner. Check it out for yourself:


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