Is the IPO Market Broken?

A few weeks ago Felix Salmon and Pascal Gobry had a pretty interesting back-and-forth about whether the IPO market is “broken” and how it can be fixed.

The one thing they agree on is that the IPO market isn’t moving in the right direction.

Back in the day, from around 1933-1998, companies would pursue an IPO to build their young companies and invest in the future. IPOs gave companies the necessary capital to grow their companies over the long term. Companies like Apple and Microsoft used new funds to develop the Macintosh and Windows. In other words, going public was expected to be the starting point for a strong and lasting future. Today, as post-Dot-com bubble regulations have forced companies to wait longer to go public, IPOs have become a reward for early shareholders rather than a source of funding for new companies.

Salmon explains how today, venture capital firms looking to cash in on their investment as soon as possible are pressuring companies to sacrifice cash flow for inflated revenues. Pursuing growth at such breakneck speed is risky not only for the long-term survival of the company, but for the stability of the economy as well.

Gobry points to the fact that regulations like Sarbanes-Oxley are making it more difficult for young tech companies to go public, which denies small companies the financing options, tax advantages, and prestige needed to grow. Salmon argues that young, VC-backed companies are increasingly being pressured to sacrifice long-term growth for short-term revenue as soon as they go public.

Venture capital firms invest in hundreds of companies a year. Most don’t go public, and the ones that do rarely become superstars like Facebook or LinkedIn. Is this just part of capitalism? Do these companies fail because VC firms pump up their revenues at unsustainable rates, or do the majority disappear simply because of the “go big or go bust” nature of high tech companies?

Salmon’s fix: Enter the private markets. If companies sell shares through private markets, including online platforms like SecondMarket and SharesPost, they can control who buys their stock and thus be less vulnerable to the volatility of outside power and influence.

Gobry’s fix: Make going public easier. Get back to the days of "small, quick, easy IPOs relatively early on in a company’s life, where it can then tap the financial markets to keep funding its growth and have access to all the perks of going public."

Both of these solutions have some flaws. Private markets are inefficient, and most people don’t have access to them. Moreover, I think Salmon underestimates the value of VC firms a little too much. Gobry doesn’t really offer up a solution other than relaxing regulations. What do you think? Is there a viable solution to ensuring the IPO can create healthy, long-lived companies as opposed to flops that run out of steam?