An IPO Reincarnation?

In spite of a rebound this year, the IPO markets — a key source of capital formation for entrepreneurial America — are in a shambles.


Jeff Jordan, chief executive officer of OpenTable Inc., center, celebrates with company representatives after the opening bell at the NASDAQ MarketSite in New York, U.S., on Friday, May 22, 2009. OpenTable Inc., the restaurant-reservation service, soared 59 percent after the company’s initial public offering yesterday defied the slowest IPO market in decades. Photographer: Zef Nikolla/Nasdaq via Bloomberg News EDITOR’S NOTE: NO SALES. EDITORIAL USE ONLY.


At the end of this year, the number of IPOs of venture-backed companies for 2010 will be greater than the combined total of venture backed IPOs in 2008 and 2009. But in spite of the rebound, the IPO markets — a key source of capital formation for entrepreneurial America — are in a shambles.

Still, the task of reviving the IPO markets may not be as Herculean as some suggest. Simply re-invent the Four Horsemen — if not in body, certainly in form. Re-think Regulation. Re-incentivize capital providers without breaking the bank.

The four horsemen — Alex Brown & Sons, Hambrecht & Quist, Montgomery Securities, Robertson & Stephens — together with LF Rothschild Unterberg & Towbin (in the 1980s), Cowen & Co. and a few others, were the primary bankers to entrepreneurial companies. Through the 1980s and 1990s they had the major share of underwritings of IPOs of venture-backed, technology-related companies.

But these horsemen were more than just underwriters. they often provided venture capital, they provided wide-encompassing research and they provided after-market support. To some industry watchers they often were more cheerleaders than objective bankers and their dealings often came close to what many would now consider insiderism... But on the whole these specialist bankers were the linchpins of the entrepreneurial ecosystem.

By the year 2000 all of the horsemen had disappeared, acquired by large bulge bracket funds. Chase paid $1.35 billion to buy H&Q; NationsBank $1.2 billion for Montgomery; the price was right. “It was the right time to sell,” acknowledges one insider. But he also feels that the business model that had sustained the boutiques had broken down.

Because investment banking did not pick up the tab anymore — the smaller shops simply couldn’t pay for the research that many of these companies needed. Meanwhile a plethora of market forces drove down trading commissions to such low levels that small shops simply couldn’t make it pay.


Rethink regulation. A flurry of regulations helped kill the boutique shops, say David Weild and Andrew Kim in their “Market Structure is causing the IPO crisis – and more,” a white paper prepared for Grant Thornton.

• FINRA’s order precedence rule, commonly known as the Manning Rule, narrowed spreads and “economics to firms continued to erode.” Support of stocks decreased dramatically.

• Regulation ATS, which provided for the integration of Electronic Communication Networks (ECNs), crossing networks and others brought an explosion of new competitors and even greater pressure on trading margins.

• Gramm-Leach Bailey, passed in 1999, led to increased concentration in the financial services industry, creating conglomerates that served to decrease competition and increase systemic risk.

• Decimalization — decimal pricing for stocks and options — removed economic incentives for firms to provide research and liquidity support for stocks. “The last bit of economics left for retail stockbrokers to market stocks is stripped away.

Weild, whose Capital Markets Advisory Partners, works with entrepreneurial companies in helping them formulate capital formation strategies, isn’t for scrapping regulations but re-thinking them and their impact on capital formation. Have they helped investors become more informed? Is the market, especially for entrepreneurial companies, more efficient?

Create incentives for investing in entrepreneurs and entrepreneurial companies.

A number of states — most away from the entrepreneurial mainstream — have enacted programs such as the Certified Capital Company (CAPCO) program to provide tax credits to venture capital investments. For various legal and practical reasons, the benefits of investing in CAPCO programs have generally been restricted to insurance companies. Does it make sense to expand such programs to benefit entrepreneurial companies in varying stages of development (private and public) and a wider range of investors?

Other states, including Maine, Missouri, Indiana and Iowa, offer tax credits for seed capital investment in small businesses, tax credits that act as front-end incentives for angel investors.

The cost-benefits of incentive programs are still up in the air. In most cases, it may be too early to tell. But given the current approach to economic development — massive infrastructure investments that buy a handful of jobs — how expensive can incentives really be?