Point No. 1: There are a handful of theories as to why there are fewer IPOs these days, but I’d like to highlight a key reason that I think is greatly underrecognized. Hint: It’s all about ecosystems.
Point No 2: Fewer IPOs is not a good thing, again, for reasons not so obvious. Hint: It’s all about inequality.
Before I explain, here are the numbers:
Up to 230 companies will likely go public in 2019 if the market doesn’t tank, Renaissance Capital predicted earlier this year. And while the number of IPOs has been climbing some over the past several years, it’s actually still on the low side historically. From 1980 to 2000, an average of 310 companies went public in the U.S., according to Jay Ritter, a professor at the University of Florida. (In boom years there were hundreds more.) After 2000, the yearly average dropped to 110.
Venture capital and M&A madness
Why is that?
First off, the IPO pipeline went bone-dry after the dot.com crash of 2000, but truth be told it never really recovered after that.
There are a number of generally accepted theories why fewer companies are going public. One big reason: They don’t have to. Silicon Valley is awash in money. The venture capital business used to be a fairly small marketplace, but no more. For a number of years now, institutional investors have been flooding in with cash. “Private investors poured $130.9 billion into technology and biotech companies last year, far outpacing the $50.3 billion raised via IPOs and follow-on offerings,” writes Jane Leung, chief investment officer at Scenic Advisement, an investment bank for private tech companies in San Francisco. Leung notes this outpacing has been going on for a decade.
No wonder the “unicorn”— a private tech startup worth more than a billion dollars — has become emblematic of this Silicon Valley boom. Telling too, that the metaphor was coined by a VC, Aileen Lee, in 2013.
But there’s another, underappreciated, reason why there are fewer IPOs. And that is simply because so many hot startups are being gobbled up by big tech companies. This isn’t a completely new phenomenon. Back in the 1990s, companies like Cisco (CSCO) were positively M&A mad. But there’s something very different afoot now, and it has to do with a major strategic impetus in Silicon Valley these days, that being the creation of so-called ecosystems.
At its core, an ecosystem is a business model where a tech company looks to serve as many customers in as many ways possible — and even beyond that, one part of the business helps grow the other. Of course in the digital world the potential for a company to jump into one business after another is almost limitless. And so Google (GOOG, GOOGL), Amazon (AMZN), Apple (AAPL), and Facebook (FB) — the Murderers’ Row of ecosystem companies — expand from one market to the next; from search to music to ecommerce to payments to delivery to driverless cars to drones.
Scale and speed are seen as critical when building an ecosystem. The most efficient way to accomplish that? Buy companies. Lots of them.
A shift to a handful of high-growth companies
I went through Crunchbase to look at some of the dealmaking, and the numbers are staggering. Since 2012 Facebook has bought 77 companies. (The U.S. Federal Trade Commission is now even scrutinizing Facebook’s major acquisitions as part of an antitrust inquiry, according to news reports from Aug. 1.)
That’s over 500 companies snapped up — by just these four tech giants. Names like Instagram, YouTube, Android, Waze, Nest, Twitch, Zappos, Beats, WhatsApp, Oculus, and on and on. Sure, investors have reaped gains to a degree if they owned the parent companies’ shares, but maybe not as much as if these companies IPOed.
There’s nothing wrong with ecosystems per se, or with companies staying private longer for that matter. But overall these trends have reduced the number of IPOs, and significantly, shifted the gains that these high-growth companies might have produced in the public markets (benefitting ordinary investors) to private markets (benefitting venture capitalists and their ilk).
Is this making wealth and income inequality worse? It can’t be helping.
Don’t believe me? Ask Jay Clayton, chairman of the Securities and Exchange Commission, who said this in a speech at the Economic Club of New York two years ago: “To the extent companies are eschewing our public markets, the vast majority of Main Street investors will be unable to participate in their growth. The potential lasting effects of such an outcome to the economy and society are, in two words, not good.”
Got that right, Jay.
Reining in ecosystems might not be in Mr. Clayton’s purview. Making sure our capital markets are fair and equitable to all investors, is.
This story was originally published on June 24, 2019 and updated on Aug. 2, 2019.
Andy Serwer is editor-in-chief at Yahoo Finance. Follow him on Twitter: @serwer