In June, the high-tech car service Uber raised $1.2 billion in a venture capital round that valued the company at $17 billion. It was the latest sign of a dramatic change in how fast-growing companies are financed.
Two decades ago, companies as large as Uber were almost always publicly traded: listed on a major stock exchange and available for anyone to invest. For example, when Microsoft first offered its shares to the public in 1986 — an event known as an initial public offering — it was valued at just $1.1 billion ($2.3 billion in 2014 dollars). In contrast, Facebook didn't have an IPO until 2012, when the company was worth $104 billion.
Those figures reflect a broader trend: startups are waiting longer and longer to go public. To find out why, I talked to Scott Cutler. He runs the global listings business at the New York Stock Exchange. When companies want to have their stock traded on the world's biggest stock market, Cutler is the guy they talk to.
Cutler, who worked as an investor in Silicon Valley before moving to the NYSE, offered two theories for why companies were waiting longer to go public. One, it's easier to raise private venture capital than it used to be. There are a lot more venture capital firms with a lot more money to invest. So companies can grow for longer without having to tap the public markets.
Second, going public entails higher regulatory burdens. After the collapse of firms like Enron and Worldcom in 2001 and 2002, Congress and the Securities and Exchange Commission tightened regulations on public companies. That has raised the cost of going public and encouraged companies to stay private longer than they once did. Cutler is a fan of the JOBS Act, 2012 legislation that relaxed some of those regulatory requirements in order to encourage more participation in the public markets.
I've edited the interview for length and clarity.
Timothy B. Lee: How has the IPO market changed between the 1990s — when you were an investor in Silicon Valley — and today?
Scott Cutler: They are two different worlds. The world of pre-2000 was a different world in terms of the amount of capital that was raised in IPOs and the depth and development of the venture capital market. There was a completely different regulatory landscape around the public markets. Before 2000, there was this model of taking companies public early, research that supported it, and a whole banking environment around that.
The IPO market today is very different than it was in the 1990s. You had huge financial frauds at Enron and Worldcom and the resulting regulation that came out of that in Sarbanes-Oxley. There was complete restructuring of the US capital and trading markets, with the introduction of decimalization, RegFD, RegNMS, and RegATS. Fast forward through another financial crisis and there we are today.
In the the 1990s, there were years when there were over 500 IPOs in the US. I think in looking at that, you also have to look at the nature of many of those IPOs. Many of those IPOs were $30 or $40 million capital raises for a $200 or $300 million market cap company. Intel want public on a $30 million IPO and a $180 million market cap. Today, that's a Series C financing in the private markets.
You didn't have venture investors back then that were writing $100 or $200 million checks in one company. There were entire funds that were $100 or $300 million to invest in those companies.
So it's not that the public markets have become less desirable, it's simply that the entire market has changed in terms of how capital is raised and from whom.
TBL: Then why go public at all? Couldn't companies just remain privately financed indefinitely?
SC: One reason companies go public is access to permanent capital. That provides liquidity for the employees, the investors, and the founders. It provides a currency for mergers and acquisitions.
Going public also is a different part of the curve for the acceleration of a business. It becomes a real company in the eyes of many customers and partners and potential customers. And so companies use that IPO as a branding event with customers and partners, and as an accelerant to their business.
Those fundamental advantages of the public markets are as strong now as they ever have been even though the private markets are flush with capital.
The NYSE provides a centralized marketplace that provides the most money to invest in stocks of any other platform or exchange in the world on the equity side. We're responsible for trading nearly a third of the world's equity. It is the center for global capital raising in the world. There's no other exchange that raises more money in IPOs than the NYSE.
TBL: Let's say I'm running a company and I want to raise from the public markets. What does the process look like? I go to an investment bank first, right?
SC: Effectively, the bankers are responsible for helping position the company for investors. They're brokering a transaction to sell those securities to mutual funds, institutions, and individual investors. At a very certain point in time, they buy the stock from the company and then sell that at the same time to those who are interested in buying that company. That's their role as an underwriter, to underwrite those securities for sale to public investors.
The bankers are responsible for preparation and marketing of the process. In the exchange, we provide a platform for that interaction with the public market investor, for the first time, in the life of a public company.
TBL: Some people have a perception that companies such as Facebook only go public when SEC regulations essentially force them to do so. Do you think that's true?
SC: I don't believe that executives today fear the public markets. It is a high bar to be a public company for good reason. You're reaching that bar so that you can sell your stock to any investor in the marketplace. So you have higher standards of disclosure, higher standards of communication that is expected public companies. That's not something to be afraid of, it's just when you're ready as public company to meet that scrutiny, you're ready for the public markets.
Being a public company does require more infrastructure, more controls around your financials, a whole set of infrastructure around governance on the board, very developed investor communications programs, solid understanding of your financial projects, of your strategic landscape, what you're going to do with the money, and a whole set of regulations that also include filing documents with the SEC.
All of that comes with cost and infrastructure. It's much more costly to operate as public company than a private company, no question. The debate around that is at what point does the pendulum swing so far that access to public markets is too expensive or the regulations are too burdensome? Where does it start to push companies away from the public markets?
TBL: Critics have argued that the 2002 Sarbanes-Oxley legislation has deterred companies from going public.
SC: It did over a period of time until those standards were baked into best practices, which is where the case is today. Now, one can always argue, is all of that infrastructure necessary? That's not my argument to make. I would say the first number of years after Sarbanes-Oxley had very much of a chilling effect. It dramatically increased the cost of going public. When we traveled around the world in that period of time, before the 2008 financial crisis, there was a lot of question about how competitive the US market is going to be in the future because of excess regulation.
TBL: The JOBS Act, which Congress passed in 2012 has made some changes to the way public companies are regulated. Has that made a difference?
SC: It has in a couple of respects. First, it allows companies under a billion dollars in revenue to go through the process with the SEC confidentially.
Certain financial requirements and disclosure requirements were made more efficient and reduced the actual costs of going public. It pulled several hundred thousand dollars out of the costs of going through the process.
Those two changes alone actually changed the sentiment among executives and investors around the world immediately after that law was put into place. Since then, we've seen year over year increases each year since the jobs act was put in place (in February 2012) in terms of capital raised and numbers of IPOs.
TBL: A number of companies offer multiple share classes that have different voting rights. Do you think this makes IPOs more attractive for founders like Facebook CEO Mark Zuckerberg?
SC: No, that structure has been in place for a long time. Closely-held companies like Ford and Warren Buffett's Berkshire Hathoway, have had this type of structure. So it's nothing new in terms of governance or voting rights at all for the US market. In fact, we've got north of 300 companies listed on the NYSE I believe, out of our 2000 companies, that have dual-class structures.
If there's an argument to be made against the structure at all, which is the case mostly outside the US, it's that once you're a public company, the public should be able to control what you do as a company; the company shouldn't be controlled by the founders or a small group of people. But that's a structure the US has been comfortable with for decades.
TBL: How should ordinary investors think about IPOs? Should they be trying to buy stock in IPOs, or wait until the post-IPO period to buy in?
As a category of public equities, an IPO would be on the riskier scale of investments, because these are unproven in the public markets, a lot of time, it's the first time the company is traded publicly, creating its own track record. Investors, as they're entering into, or want to buy an IPO, should be very familiar with risks associated with the business. Those are all disclosed in the prospectus and the offering document. The reason that those documents are so lengthy is to give investors fair disclosure around what they're buying, and the risks associated with that as well as the opportunity.
There's the pre-market and then the market. In the pre-market, the stock is generally placed to institutional investors, so those are places that we have our money in, pension funds, mutual funds, stock indices, so those are typically the anchor buyers in an IPO, and typically some allocation to the retail shareholder. You typically have to be an account holder at ones of the banks that's underwriting an IPO to get access to those shares. Largely limited to 10 or 15 percent of the average IPO.
TBL: Can individual investors participate indirectly in IPOs via mutual funds?
SC: Yes. Large mutual funds such as Fidelity, Vanguard, Wellington, Morgan Stanley, and T. Rowe Price are big buyers of IPOs, and anybody can invest in those mutual funds. There are also large pension funds that hold the retirement plans for unions and teachers and anybody who receives a pension, those are also huge buyers of IPOs as well.
So John Q. Public does have access to the pre-IPO market, through mutual funds and pension funds and retirement plans, that invest in these types of assets, both private and public.