Too-Early IPOs Create Problems

Companies are taking longer to go public these days, but Washington should not view that as a problem it needs to fix.

“In today’s environment,” writes former Cisco CEO John Chambers in a recent cnbc.com essay, “companies are staying private longer and longer.” In 2018, he notes, less than half as many companies went public as in 1996. This change disadvantages “the average American,” Chambers argues. Investors earn a higher return when they buy into a company in its early, rapid-growth stage, rather than being compelled to wait for a long-delayed IPO.

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Fostering a more vibrant IPO market is vital to the national interest, according to Chambers. He urges current presidential candidates to embrace the cause in order to facilitate “job creation, increased income and inclusion of all citizens.” Chambers, who now heads a venture capital firm, might have added that a strong IPO market aids VCs’ ability to monetize existing investments and move on to finance new startups.

Chambers, recognized by Harvard Business Review as one of the world’s best-performing CEOs, speaks with firsthand knowledge of the benefits to investors of successful IPOs: “Cisco’s IPO, for example, allowed investors who put $1,000 in our stock in 1990 to grow their investments to more than $156,000 by the end of 2015.”

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This is exactly the kind of gusher that “the average American” with a dollar and a dream hopes to find. There is another side, however, to the conditions that created the 1990's IPO boom.

Among the enterprises that went public back when IPOs were running at twice the current rate were a new breed of telecommunications providers dubbed “business plan companies.” Far from deferring their IPOs until after the big money had already been made, they had not yet generated much in the way of revenues, much less profits. Furthermore, a shakeout that would cull many lookalike competitors was inevitable.

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In the context, however, of IPO buyers throwing money at dubious dotcoms, telecoms with only a business plan, rather than a business, received an enthusiastic welcome.

A more sober corporate finance assessment would have concluded that many of the era’s telecom issuers were at too early a stage to justify a migration from venture capital to public equity. Underwriters, though, were delighted to collect fees on $23.9 billion of telecom IPOs in 2000, up by 94% from the previous year, according to CommScan Analytics.

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Telecom Bankruptcies of 2001

Covad Communications

e.spire Communications

Excite@Home

Exodus Communications

Metricom

NorthPoint Communications

PSI Net

Rhythms Net Connections

Teligent

Winstar Communications

Source: money.cnn.com

The day of reckoning was not long in coming. In 2001, all the telecoms listed in the accompanying table went bankrupt. Things got worse from there:

Job destruction, rather than job creation, was the economic theme of this debacle. As for those average Americans, it seems clear that they did not all find a Cisco-like needle in a haystack.

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Chambers blames today’s less robust IPO market on several factors, including increased regulatory burdens, shareholder activism and the public market’s short-term mentality. These impediments, however, also existed in the IPO heyday of the 1990s. Perhaps, then, startups’ reduced urgency about going public is mainly a function of one additional factor that Chambers lists—wide availability of private funding.

Private capital competes with public market financing. If entrepreneurs prefer the former, it is probably because they believe it offers them a better deal. Presidential candidates running on a free enterprise platform surely should not advocate government intervention to favor one competitor over another. Not even if that policy would benefit exit-seeking VCs and average American investors.

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Martin Fridson is editor of Forbes/Fridson Income Securities Investor.

Illustration for article titled Too-Early IPOs Create Problems

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