Updated: Jun 15, 2020
One fascinating trend that has emerged from the Covid-19 pandemic is the resurgence of IPOs in the United States. However, before analysing this trend, it is vital to answer the following question:
What exactly is an IPO?
An IPO (initial public offering) is the first time that the stock of a private company is offered to the public. IPOs provide entrepreneurs with the capital and equity to further invest in and grow their business, as well as the opportunity to enhance their reputation.
IPOs are a big deal. Out of the millions of companies in the U.S., there are only about 5,000 companies listed publicly on the two major U.S. stock exchanges - the New York Stock Exchange (NYSE) and the NASDAQ stock exchange.
This surely allows us to come to the quick and easy conclusion that most companies steer clear of the public market. But, if companies are not listing publicly, one has to ask why companies do not want to go public?
Why might a company not want to go public?
IPOs are not attractive for a number of reasons:
1) Companies have options to raise capital in other ways, so do not necessarily need to go public. Post financial crisis, big banks have become more heavily regulated. As such, venture capital firms, sovereign wealth funds, and private equity funds are all increasingly involved in the financing of companies, with the PE industry having trillions of dollars in assets under management.
2) Smaller private companies are often more attractive acquisition targets for investors. Private companies do not have to meet Wall Street’s expectations, meaning that the company can retain a focus or strategy that appeals to certain investors.
3) Congress has extended the IPO Runway, making the already lengthy process even more complex and stringent.
4) The process of an IPO requires a lot of work. This can be a source of distraction and aggravation for companies’ leadership teams, which could subsequently lead to a lack of focus on the businesses’ true aim - making profit.
5) An IPO is very costly. The process of an IPO requires investment banks, such as Goldman Sachs or J.P Morgan (to name a couple), to guide the company through the process. This comes at a great financial cost with banks often gaining 3-8% of the valuation, as well as various commission charges and advisory fees. The more parties involved in an IPO, the more difficult and costly the process will be, and the longer it will drag on.
6) Public companies are constantly scrutinised by regulators such as the Securities and Exchange Commission. Companies are required to provide significant detail on the business, right from its ownership structure to its nature of operations, which companies can sometimes be hesitant to do. For example, after Imperial Holdings' IPO in 2011 it became apparent they were faking claims of profitability, leading to a 75 per cent share nosedive and eventual suspension of trading. Many companies cannot afford to be so transparent.
A tool for the good, but not always…
IPOs can work wonders for companies, and lead to increased success, notoriety, and growth. However, it does not always turn out this way. Below are just a few examples of other companies that have failed after promising IPOs:
- King Digital Entertainment (2014), the company that created Candy Crush Saga. This IPO ultimately failed due to the lack of diversification beyond the single game, leading to a 20 per cent share price drop in the first week.
- Zynga (2011) well-known by many for its popular poker game and Words With Friends similarly did not live up to its promise due to lack of diversification beyond free-to-play games.
- Omeros (2009), a development-stage biopharmaceutical company that had a 36 percent share price decline in the first two weeks after its IPO.
- Refco (2005), an electronic trading business that collapsed within 2 months of going public after the company announced accounting fraud by the chairman and CEO.
The reasons for each companies’ failures post IPO, whether that be filing for bankruptcy/insolvency or dropping 50% in value, are each very different but are all nonetheless very interesting scenarios. Each scenario gives valid reason for future entrepreneurs to tread carefully when going public, and as such, these failures further justify why there has been a decrease in IPO filings until recent times.
The resurgence of IPOs in the U.S.
Presently, U.S. Companies are bringing forward plans to go public. Last week delivered $3bn in proceeds from IPOs, the biggest figure since May 2019. Demand peaked on June 3rd, 2020, when Warner Music and fintech Shift4 Payments had their deals expanded, as orders exceeded the amount of stock on offer.
Other notable IPO pricings include ZoomInfo who raised $935m last week. Likewise, Snowflake, a cloud database start-up who are aiming for a $20bn IPO valuation, is among the increasing number of companies looking to go public. Perfectly evidencing the renewed demand by investors, specifically for fast-growing technology groups, this IPO, with the help of Goldman Sachs, would surpass social media company Pinterest’s IPO, if the valuation under discussion becomes a reality.
To further emphasise this point, Paul Abrahimzadeh, co-head of North American equity capital markets for Citi, remarked that we are “going to see a lot more IPOs coming.” Carter Mack, president of JMP Group, stated he is working with a “record backlog” of IPOs.
However, despite this surge in equity issuance, and optimism being shown through the markets, Covid-19 is still at the forefront of proceedings. People are scared of the unknown. With asset prices detached from reality, economic forecasts looking inauspicious, and protests sweeping through the U.S., alongside the looming presidential election in November, the market conditions for the second half of 2020 are uncertain.
Some closing notes
There are several remaining questions that must be answered. Will an IPO help a company grow? Countless IPOs have brought success and great fortune for investors and companies alike, but equally, some high-profile ones, such as Uber, or the ones mentioned above, have not turned out to be as successful as planned. There are many advantages of going public, and companies obviously believe that now is the optimal time in the market cycle to do so!