Small companies' inability to raise capital is having a deleterious effect on the economy, according to recent studies.
Firms raising $50 million or less made up the lion’s share of stock market debutants in the mid 1990s — about 80 percent of the total in a typical year. In recent years this has slumped to around 20 percent. A recent Treasury Department task force on the issue calculated that IPOs of such dynamic young firms had dropped by three quarters over the past decade, compared to the 1990s.
Between 1997 and 2001 the average new stock market entrant was five and a half years old. Since then the average age has climbed to nine. And a growing number of firms are being swallowed up by larger rivals and so never come to market.
Why is this a problem for the macroeconomy as well as investors?
Emerging growth companies less than five years old tend to have a voracious appetite for workers. Indeed, one study by consultancy IHS calculated that such business accounted for all net U.S. job creation between 1980 and 2005. It is also significant that about 90 percent of this spurt of hiring only came after firms had listed on the stock market — presumably because of the infusion of fresh funds. Acquisitions do not produce this job explosion, the Treasury’s task force argued. Indeed, they concluded that “M&A events result in job losses in the short term” and that subsequent employment gains are more modest.
So the decline of small firm IPOs may have cost the U.S. about 22 million jobs, according to a study by David Weild and Edward Kim for accountancy firm Grant Thornton. Weild also believes that a lack of access to public funding is sapping innovation. “This is having a more catastrophic impact on the U.S. economy than the 2008 credit crisis,” he says. “It might not be such a big bang, but it is far more insidious, starving small companies of the capital they need to expand.” A broken IPO market weakens the entire funding chain for firms — making life harder for venture capitalists and angel investors. The consequence, he worries, will be a less innovative economy.
America does not appear to be alone in suffering from this shortfall. London’s Alternative Investment Market, which specializes in younger firms, has seen listings fall to a seven-year low. Still, the problem has been most acute in the United States. The number of publicly traded firms has fallen by 43 percent since its peak in 1997. Nor does the shortfall appear to be inevitable. Small-company listings are flourishing in China even at times when larger firms are struggling to raise funds — as witnessed by the remarkable growth of Shenzhen’s growth-company market ChiNext.
This problem has finally attracted the attention of Congress. Senators Pat Toomey and Chuck Schumer have proposed a bill to jump-start small IPOs, the “Reopening American Capital Markets to Emerging Growth Companies Act.” The main focus of the bill is to reduce red tape for market newcomers. The question is whether the congressmen have correctly diagnosed the causes of the problem.
