With all the hubbub surrounding young technology companies such as Snapchat and Pinterest, you might expect initial public offerings to erupt left and right in the sector. But that isnt the case.
The dollar value of tech IPOs has plunged 88 percent through September 18 this year, to $4.49 billion, compared with $37.37 billion during same period of 2014, according to financial data provider Dealogic. Technology shares have been hit hard in the recent stock market correction, with the tech-heavy Nasdaq composite index dropping 9 percent since August 17.
Several factors explain the drop. First, plenty of venture capital is available for young tech companies, so they dont need an IPO to gain financing. And investors, company founders and employees no longer need an IPO to cash in some of their company shares (which can be sold on secondary markets, in later rounds of venture capital funding and through sales of the entire company to bigger competitors). In addition, many recent tech IPOs have performed poorly. And IPOs bring hassles for the companies, such as quarterly earnings reports and dealing with activist investors.
As for the availability of capital, the Federal Reserves low-interest-rate policy is pushing investors to take greater risk. Some of those investors are flocking to venture capital. Even mutual fund managers such as Fidelity Investments and T. Rowe Price have jumped in the funding pool. There is a lot of money floating around chasing returns, says Simon Olson, a former Google executive who recently founded Galactic, a São Paulobased wealth management firm. Uber and Airbnb have been able to raise billions of dollars at high valuations. In the past, not so much money was available for tech companies later-stage funding rounds.
In addition, it has traditionally been cheaper for companies to obtain capital through an IPO than via late-stage venture capital. But now VC firms are happy to invest on terms favorable to the companies, says Rick Summer, an Internet and technology equity analyst at Morningstar in Chicago.
Theres also an image issue at work for venture capital firms, says Vassil Mladjov, a research director at tech analysis firm Gartner in Santa Clara, California. Its sexy for VCs to say, We have many unicorns, rather than IPOs, he says. Unicorns are privately held tech companies with a valuation of at least $1 billion that are now all the rage for the tech set. VCs are willing to pay a premium to get a unicorn in their portfolio to look relevant, Mladjov says. Thats the new standard.
When it comes to strategic sales to bigger players, getting big fast is more important that it once was, says Jay Ritter, a finance professor at the University of Florida. For a company with a hot technology, growing organically takes too long. Greater value can be realized if the company sells itself in a trade sale. Big tech stalwarts such as Microsoft Corp., Oracle and Cisco Systems are more than happy to snap up small companies with promise.
Not all the IPOs that have taken place worked out well for investors, mind you. Shares of Twitter, which went public in November 2013, have dropped 38 percent from their first-day close. Cloud content company Box, which issued shares in January, has slumped 45 percent. Start-ups that could go IPO saw that these companies didnt deliver. That made people think twice, Mladjov says.
Then there are all the regulatory requirements for a public company. For years entrepreneurs have been complaining about the Sarbanes-Oxley Act of 2002, which created stricter reporting rules. They also arent keen about having to focus on quarterly profits and potentially having to deal with activist investors. There are costs associated with being public, Olson says. Its not as fun anymore once youre a public company. So, if youre able to stay private, why not?
The trend may become self-reinforcing, he says. Since these companies are taking longer to go public, returns are increasingly captured while companies are still private. If returns are now captured in the private stage, that will be a driver for investors to invest in the private stage, rather than the public stage.