Image: Amur leopard, a critically endangered species. Source:
World Wildlife Fund
According to a recent Forbes article, America ranks as the best
country for female entrepreneurship. That’s “good.” On the other
hand, the “bad” is that companies founded by women entrepreneurs are
less likely to be funded by a venture capital firm than the Earth being struck
by an asteroid, as I discussed previously in this space.
That’s “not so bad,” though. Women entrepreneurs are
not missing out on much by not being funded by venture capital firms =>
since venture capital firms fund only approximately five of every 10,000
startups in America, according to Entrepreneur.com.
The “worst,” news, however, is that women
entrepreneurs will join their male counterparts in struggling to raise capital
to keep their businesses alive because of the lack of investment capital for
start-up businesses in America as a whole.
This lack of investment capital for US start-up businesses is an
endemic problem. Like an invisible chain, it extends across the length and
breadth of the US and restrains an entire ecosystem, beginning with startups in
a garage, and extending to OTC Markets traded companies, and further extending
to smaller-cap publicly listed companies.
Without sufficient capital, these businesses fail.
Predictably, many would-be entrepreneurs decide to keep their
day jobs rather than taking the entrepreneurial leap when they see the
businesses of their friends, neighbors, or relatives go “out of business” and
the often-consequent loss of life savings and the family home.
With this background in mind, you might be thinking that fewer
and fewer Americans want to become entrepreneurs today than in previous years.
You are correct.
The data demonstrates that entrepreneurship in America is dying.
In February of this year, Mr. David Weild IV, “Father of JOBS Act
1.0,” former Vice Chairman of NASDAQ and New York investment banker, gave
a presentation at The Yale Club of NYC. The JOBS Act, signed into law by
President Obama in 2012, was a great start for the movement to level the
playing field for emerging growth companies, but even Mr. Weild will tell you
that more needs to be done.
The presentation included a “heat” map, derived from
Census Bureau statistics of US business formations by state per capita. The
heat map shows business startups by state, per capita, in 2006 versus 2017. In
2006, the map shows much of the US as dark red, connoting high numbers of
startups per capita. Disturbingly, in 2017, the map shows much of the US as
pale pink, connoting a paucity of startups.
Business Formations within 4 Quarters by State – Per 1,000
People
And, while entrepreneurship in America is dying, so are the US public markets according to some. Others say the public markets are inhospitable to smaller cap companies or that the public markets are “broken.” Regardless of the choice of words, the US public capital markets are no longer the envy of the world, as they once were. To wit:
(1) 3,500 (40%) of the approximate 8,700 NASDAQ/NYSE trading
symbols (mainly smaller-cap issuers) have average daily trading volumes under
50,000 shares per day, and approximately 50% had volumes under 100,000 per day,
according to the SEC.
(2) There are approximately 50% fewer public companies today
than 20 years ago.
(3) The number of book runners for smaller IPOs (<$100
million in proceeds) has decreased from 162 in 1994 to 31 in 2014.
Americans are struggling. The US public markets are dying.
Entrepreneurship is dying. It’s time for Congress or the SEC, or both, to adopt
pro-capital formation policies before matters continue to get worse. If not
remediated, the US will forfeit its position as the financial capital of the
world. And, that would be really, really bad.
More on this topic to follow.
Article originally published on November 25, 2019 by equities. com here.
Ronald Woessner This is a reprint of an article of mine originally published by equities.com at the link here.
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Public Policy is Killing Stock Markets for Smaller-Cap Companies
US Public policy has caused the well-publicized and alarming decrease in the number of US publicly-listed companies and is poisoning the public markets for smaller-cap companies.[1]
The number of US publicly-listed companies
decreased over the last two decades by about 44%, from 8,823 in 1997 to 4,916
in 2012, according to the World Federation of Exchanges. A 2018 academic study from the Harvard
Kennedy School reveals similar numbers.[2]
Other countries are lapping the
US in the number of their public company listings versus our public company
listings. During the comparable period in other developed countries, public
listings increased by about 48%.[3]
The US “should have”
approximately 10,000 public companies today, resulting in an estimated
“listing gap” of approximately 6,000 companies.[4]
This
decrease should be shocking and frightening to all Americans, regardless of
party affiliation, particularly when one considers that real GDP has grown by
over 60% in that time frame. Why, when our economy is growing strongly, has our
public listing machine come to a grinding halt?
This
decrease has cost America tens of millions of jobs,[5]
reduced to a mere trickle the queue of future “Fortune 500” larger-cap
companies for Fidelity, CalPERS and hundreds of pension plans to invest in,[6]
and puts the US on the vector of falling behind China in China’s quest to
dominate the US technologically.[7]
Here’s the chain of causation that’s created the US Listing Gap:
Step 1: The introduction of electronic trading
execution, order handling rules, and smaller tick sizes collapsed buy/sell
trading spreads to $.01 from $.25 per share and collapsed retail sales
commissions to $5.00 per trade from $250 per trade.[8]
Step 2: These smaller bankable
spreads and reduced retail sales commissions DRASTICALLY reduced the
profitability (i.e., ability to make
money) of smaller and mid-size broker dealers. This drove 74% of IPO
bookrunners out of business[9] and drove 29% of
broker-dealers out of business.[10] Those remaining eliminated the investment
banking, research, retail sales, and capital committed to market making (i.e., creating stock trading liquidity) they
previously provided for smaller-cap companies.[11]
Step 3: Lack of this
“after-market” support from smaller and mid-size broker dealers has
left thousands of smaller-cap companies as public-company “orphans,”
with no broker-dealer or investment-banking sponsorship, and poisoned the public
markets for smaller-cap companies.[12]
Step 4: This
in-hospitability deters smaller-cap companies from conducting IPOs and going
public. The big investment banks discourage these smaller deals with smaller stock
trading “floats,” as they are difficult to market to their most
actively trading institutional clients. They are also difficult transactions
purely from an ROI and opportunity cost perspective of allocated resources.
Step 5: This disappearance of the smaller-cap
company IPO (< $50M) is predominantly responsible for the US Listing Gap
according to academic research and as stated by former SEC Commissioner Michael Piwowar during his
opening remarks at an SEC – NYU conference on IPOs in May 2017: “The
substantial drop in the number of IPOs in the United States is primarily driven
by the disappearance of small IPOs.”
Former Commissioner Piwowar is correct.
The number of IPOs raising less than $100 million collapsed starting in 2000.
The number of these small IPOs averaged 401 annually in the 1990s, but then
dropped to only 105 annually in the 18 years since. In the 1990s, small IPOs
represented 27% of all capital raised in the public markets, whereas in the
period from 2000 to present they have represented only 7% of all capital
raised.[13] Moreover, according
to an OECD study, during 2008 – 2012 on a GDP weighted basis the US was
third from the bottom for small IPOs among 26 countries studied — ahead
of only Mexico and Brazil.[14]
The electronic execution, order handling
rules and $.01 tick size trading rules created the salutary benefit of reducing
stock trading transaction costs. Nevertheless, they also had the unintended
negative consequence of killing the small-cap IPO and creating the currently
poisoned US public markets for smaller-cap companies. As eloquently stated by David
Weild,
former NASDAQ Vice-Chairman, Wall Street investment banker, father of JOBS Act 1.0,
and tireless advocate for the health of the US
capital markets:
“Why
have smaller-cap company IPOs disappeared? Because the profitability of the
investment banking-focused broker-dealers —
which previously sponsored and fostered a habitable environment for
smaller-cap companies through underwriting, distributing and supporting them in
the after-market via sales, research, and market-making (capital commitment) —
has been destroyed by electronic-order execution, small-tick-size markets,
that make it easy for predatory short-sellers to collapse trading spreads
(especially in advance of offerings) and spread lies to drive down stock prices
that cannot be countered because the investment banks that remain can no longer
afford to provide research and sales coverage to counteract the lies.”[15]
Through the “butterfly effect,”[16] the electronic execution,
order handling rules and $.01 tick size trading rules had the unintended
consequences[17]
of:
killing the
smaller-company IPO market,
causing the loss
of tens of millions of US jobs,
forcing businesses
to close because of lack of capital,
discouraging
entrepreneurship,
hindering upward
mobility for all Americans, especially minorities
destroying the
efficacy of the US capital markets, and
creating an
opportunity for the Chinese to technologically dominate the US.[18]
Who
would have thought that the lack of a few pennies in tick size would have
poisoned the US public capital markets, once the envy of the world?[19]
So,
what is to be done to remedy the current in-hospitability of the public markets
to smaller-cap issuers, which is causing them to avoid the US public market?
Let’s
use our common sense to intuit the policy solution. Since the $.01 bid/ask tick
size is a root cause of the current inhospitably of the public markets to
smaller-cap companies, then one would naturally think that increasing the tick
size to some larger number would remedy the issue.
And,
indeed, academic research demonstrates this to be precisely the case!
The
academic research of Mr. Weild and his colleagues demonstrates that widening
tick sizes for smaller-cap illiquid stocks results in more smaller-cap
companies going public. In
other countries where there are higher tick-sizes-as-a-percent-of-share price (which
in turn leads to higher bid-ask spreads) their smaller-cap IPOs are booming.
There is a nearly 70% correlation between tick-sizes greater than 1% of an
issuer’s trading price and a robust IPO market for companies under $500 million
in market value, according to the research.[20]
Now, a word about the two year 2016 – 2018
SEC tick
pilot study.[21] The study increased the tick size from $.01
to $.05 for the pilot stocks. It has been reported that the study was a
“failure” because it cost investors approximately $350M more to trade
the pilot stocks during the study period and did not produce the hoped-for and
anticipated increase in the trading liquidity of the pilot stocks.[22] Commentators have
incorrectly concluded from these reports that larger tick sizes and larger bid-ask spreads do not increase trading liquidity.
These
commentators are incorrect. The failure of the tick pilot study to produce the
hoped-for and anticipated increases in trading liquidity of the pilot stocks is
100% attributable to the inherently flawed design of the study.[23]
The
study design was inherently flawed in that that
there was a null set (i.e., ZERO) of stocks
in the pilot that could benefit from the tick pilot. The explanation
appears below.
Recall that the academic research says the
tick size must be > 1% of the stock share price. The $.05 tick was not >
1% for those stocks priced > $5.00 per share. The $.05 tick was > 1% for those stocks
priced < $5.00 per share … but broker-dealers cannot recommend them for
purchase because of brokerage firm policies[24] and such stocks cannot be
purchased on margin.
Since the study design
was inherently flawed to benefit ZERO issuers, it’s not surprising that ZERO
issuers benefitted.
In
conclusion, it is clear what needs to be done from a policy perspective to
remedy the poisoned and collapsing US public capital markets: create a special
exchange with special trading rules for smaller-cap issuers that permit higher
bid-ask spreads.[25]
These
higher bid-ask spreads will then create the profitability broker-dealers need
to begin again providing after-market
“sponsorship” and support for smaller-cap companies in the form of:
investment
banking,
investment analyst
research,
providing retail sales persons to solicit customer buy orders, and
committing capital
to make a trading market in the issuer’s stock
These
activities would in turn make the public capital markets more hospitable to
smaller-cap companies, which in turn would motivate more of them to go public,
and would enable those that are already public to thrive.
A
big-tent, bi-partisan advocacy effort is now being organized in Washington, DC,
to present this initiative to Congress and to the SEC. If you want to help:
restore America’s capital markets to their former health,
create millions of US jobs,
help America’s entrepreneurs succeed,
promote upward mobility and bring millions of Americans, especially minorities and others last hired during an economic recovery, to the metaphorical “mountain top,” and
assure the US maintains its worldwide technological dominance
[1] There are approximately 5,500 “publicly-listed” companies listed on the NYSE and NASDAQ. There are another approximately 10,500 “OTC-traded” companies. The term “public markets” as used in this article refers collectively to both publicly-listed and publicly-traded companies.
[2]“Hunting High and Low: The Decline of the Small IPO and What to Do About It,” Lux and Pead, Mossavar-Rahmani Center for Business and Government, Harvard Kennedy School (April 2018), https://www.hks.harvard.edu/centers/mrcbg/publications/awp/awp86 (hereinafter cited as “Lux & Pead”). The World Federation of Exchanges number of publicly-listed companies as of December 2018 is 5,343. There appears to have been a modest uptick resulting from JOBS Act 1.0 and JOBS Act 2.0 and the robust economy.
[3] 9,538 is the estimated “should have” number as of 2012 according to the study. “The U.S. Listing Gap,” Doidge, Karolyi, and Stulz, December 2015, at p. 8.
[4] The author
extrapolates to an estimated 10,000 “should have” number in 2019.
Other commentators peg the “should have” number of public companies
as > 13,000.
[5] It is estimated
that 22M jobs were lost between 1997 and 2010 because of the reduced level of
IPO activity. “A Wake-Up Call for America,” Weild & Kim, November
2009 (hereinafter cited as “Weild & Kim”), at p. 27.
[6] Today’s Fortune
500 companies were smaller-cap companies at one time. It’s necessary to have a public market
ecosystem that enables smaller-cap companies to thrive so that those
smaller-cap companies who have the potential to become a Fortune 500 company –
have a fighting chance to do so. Today’s
public market ecosystem is so inhospitable to smaller-cap companies that many
who have the potential to become a Fortune 500 company will never achieve their
potential.
[8] “Hearing on
Legislation to Further Reduce Impediments to Capital Formation,” Financial
Services Committee, on October 23, 2013, Statement of David Weild, at 15 – 16.
[9] As of 2012, there were only 44 IPO bookrunners still in business, down from 167 in 1994. Id.
[11] The $.01 bid/ask trading spreads
have (a) decimated the ranks of the small-to-mid size broker dealers/investment
banks who formerly provided after-market support for smaller-cap companies, (b)
eliminated virtually 100% of the retail salesmen who previously phoned retail
investors and solicited buy orders for a small-cap issuer’s shares of stock, and
(c) decimated the ranks of the sell-side investment analysts who left the
industry in droves to work for hedge funds and the like.
[13] Lux and Pead at
p. 8. A delta of 296 (401 – 105) * 18 years = 5,328, which predominantly
accounts for the Listing Gap.
[14] “Making Stock
Markets Work to Support Economic Growth,” Weild, Kim & Newport for the
OECD, July 11, 2013 at p. 54.
[15] “Fixing America’s IPO Markets, Why this is Essential for US National Interests, Ideas for JUMMP Act 1.0,” D. Weild, unpublished paper, February 2019.
[16] The butterfly effect is the phenomenon whereby a minute localized change in a complex system can have large effects elsewhere.
[18]Id. There is an additional network effect that magnifies the extent of this damage. Enrico Moretti at Berkeley in his book. “The New Geography of Jobs,” wrote about the “multiplier effect” of how a single high-tech job in an “innovation hub” like Boston, San Francisco, or Raleigh-Durham creates five new jobs in the surrounding service sector. Hence, all those IPOs that didn’t happen didn’t create a successful company that then didn’t hire people that then resulted in the communities not flourishing.
For want of a nail the shoe was lost. For want of a shoe the horse was lost. For want of a horse the rider was lost. For want of a rider the message was lost. For want of a message the battle was lost. For want of a battle the kingdom was lost. And all for the want of a horseshoe nail.
[20] “Making Stock Markets Work to Support Economic Growth,” Weild, Kim & Newport for the OECD, July 11, 2013, at p. 54. For the period from 2008-2012 the U.S. had a disastrous “Efficiency Ratio” of GDP-weighted output of small IPOs — at only 0.4 IPOs per $100 billion of GDP (ahead of only Mexico and Brazil). Why? Because the US has the lowest tick-sizes-as-a-percent-of-share price of any of the 26 countries studied. A number of countries enjoy 50x the GDP-weighted output of the number of small IPOs in the US. Id.
One
may ask: “How do we know this is causation and not merely
correlation?” Answer: because we have seen from our experience here
in the US how the lower bid/ask spreads created the loss of after-market
support for smaller-cap issuers. See note 12 above and the articles cited
therein.
[21] The SEC studied for two years the effects on the trading liquidity
of 1,200 NMS pilot stocks of widening the tick size from a penny ($.01) to a
nickel ($.05).
[22] Trading liquidity
is necessary for a public issuer to attract investment firm capital. As noted
by Weild & Kim and in earlier articles of mine: without trading liquidity a public issuer has
virtually zero chance of attracting non-toxic investment firm capital. See, e.g., https://www.equities.com/news/why-do-investment-analysts-ignore-smaller-cap-companies.
[23] Early proponents of the SEC study criticized the proposed
study design at the time it was being designed.
At the time, Mr. Weild and others stated that the study design
was flawed and not remotely close to the tick size pilot they had advocated
for. The Carney – Duffy legislation,
which would have required the SEC to conduct the pilot according to certain
parameters, called for a 5- year pilot (not 2 years) and a $.10-cent tick size
(not $.05). The legislation never became
law and hence the SEC did not follow these parameters in designing the study.
[24] Brokerage firm policies prohibit
brokers from calling customers to solicit a buy order for stocks priced at
<$5.00 per share.
[25] This is the fundamental requirement. Obviously, there are hundreds of other details as well that would be necessary for such a trading venue to function properly.
+++++++++++++++++++++++++++++++++++++++++++++++++
Mr. Woessner mentors, advises, and helps companies in the start-up and smaller-cap company ecosphere raises capital through Regulation Crowdfunding (CF) and other means. He also advocates in Washington DC for policies that create a more hospitable public company environment for smaller-cap companies, enhance capital formation, support small business, promote entrepreneurship, and increase upward mobility for all Americans, particularly minorities. See here for more information on Mr. Woessner’s background.
US public companies are disappearing! This trend is 100% opposite the trend in other developed countries with similar institutions and economic development.
Many private companies avoid going public, preferring instead to “exit” their investment by selling the company, or hold off going public as long as they can.
This trend is causing US public companies to disappear. For example, US public company listings decreased over the last two decades by about 46%, from 8,090 in 1996 to 4,331 in 2016, according to a 2018 academic study from the Harvard Kennedy School.[1]
Conversely, public company listings increased by about 48% in other developed countries over a comparable period, according to another academic study in 2015. According to that study, the US “should have had” approximately 9,500 public companies in 2012, resulting in an estimated “listing gap” of approximately 5,400 companies as of 2012. The listing gap is undoubtedly higher today.
This disappearing public company trend has profoundly negative consequences for US job growth. A March 2011 report from the Department of the Treasury’s “IPO Task Force” determined that 92% of the job growth among companies who had gone public occurred after the company’s IPO.
Another negative consequence of the disappearing public company is that as public companies disappear, there are fewer public companies for mutual funds (Vanguard, Fidelity, etc.), pension funds, and the like to invest in. If current trends continue, the “S&P 500” will become the “S&P 250.”
Moreover, not only does staying private thwart US job growth, it deprives mom-and-pop “Main Street” investors of opportunities to invest at the early stage of a business and reap significant gains in value during the business’ early, private years.
To wit, Uber and AirBnB are two well-known companies that have not yet gone public and whose investors (principally Silicon Valley and Wall Street investment firms and high-net worth individuals) are poised to make HUGE sums of money on their investments. In this regard, note the recent news reports that Uber’s proposed IPO market valuation is $120 BILLION. “Main Street” investors will made ZERO from the success of these (and similar) venture capital funded companies because these investment opportunities and similar ones are not made available to them. This statement is not a criticism of the investors who stand to make an enormous amount of money (after all they took a risk with their money and are entitled to a return) – it is simply a statement of fact.
As a counterweight to this trend of income being redistributed to Silicon Valley and Wall Street investment firms and high-net worth individuals, SEC Chairman Jay Clayton wants to let more “Main Street” investors participate in private deals. Within recent months he was quoted in The Wall Street Journal as saying:
Many companies have shunned the public markets in favor of private investors,
Regulators have for decades typically walled off most private deals from smaller investors, who must meet stringent income and net worth requirements to participate,
The SEC is now weighing a major overhaul of rules intended to protect mom-and-pop investors, with the goal of opening up new investment options for them.
We thank Chairman Clayton for recognizing the need for SEC policies that permit more Main Street investors to invest in private deals. But — permitting more Main Street investors to invest in privatedeals does NOT fix the problem of the declining number of US public companies.
CAUSES OF THE “DISAPPEARING” US PUBLIC COMPANY
So, what is behind the precipitous fall in the numbers of US public companies over the past decades? The following factors have played a significant role in this alarming trend:
More and more companies are turning to the private markets for their capital needs. According to a 2017 Report by the Department of the Treasury, from 2012 through 2016, the debt and equity capital raised through private offerings was 26% higher than that raised through the public markets.
Smaller-cap companies are not going public. The small (less than $50M – $100M) IPO has practically disappeared. The number of small IPOs averaged 401 in the 1990s, but then dropped to only 105 annually in the 18 years since. In the 1990s, small IPOs comprised 27% of capital raised in the public markets, whereas in the period from 2000 to present they have comprised only 7% of all capital raised. In fact, research shows that the collapse of the smaller IPOs is ~100% responsible for the listing gap between the current number of US public companies and the number of public companies the US “should have.”
Why are smaller-cap companies not going public or delaying going public until they are larger-cap companies? Answer: because the public company ecosphere is “inhospitable” to smaller-cap public companies, as evidenced by the below:o Regulatory requirements of Sarbanes – Oxley and Dodd-Frank are burdensome
o Smaller-cap companies are vulnerable to “bear raid” attacks by short sellers
o There is little to no sell-side investment analyst coverage
o Buy-side investing trends have changed whereby retail investors are moving to mutual funds, rather than investing in individual stocks
o The threat of class-action lawsuits is a deterrent
o The public company reporting (Form 10Q, 10K, 8K) requirement is a deterrent
As if the preceding reasons were not deleterious enough: public markets also are inhospitable to smaller-cap companies for the following reason: once publicly-traded, the stocks of many smaller-cap companies are likely to be illiquid[2]; and for companies with an illiquid stock, it is virtually impossible to raise non-toxic capital from investment firms because investment firms are reluctant to invest in smaller-cap, illiquid stocks.[3]
Private company CEOs and CFOs look at all of these in-hospitability factors and determine they simply don’t want to be a public company.
Despite the foregoing, smaller-cap companies can thrive in the public markets. If you are a CEO or CFO of a smaller-cap company with an illiquid stock and your company is struggling to raise non-toxic capital => don’t despair! A subsequent article will provide you specific, actionable recommendations for increasing your company’s stock liquidity.
Subsequent articles will also unveil a policy solution that, if implemented, will reverse the trend of The “Disappearing” US Public Company!
[2] According to a 2018 SEC study of thinly-traded securities, 3,500 of 8,700 NMS-traded securities had a dismal, median average daily volume of < 50,000 shares per day.The trading volumes of OTC-traded stocks are even more dismal. A subsequent article will provide more detail regarding these dismal trading volumes.
[3] Lack of trading liquidity makes it virtually impossible for investment firms initially to invest through the open market without affecting the stock price – similarly, lack of liquidity makes it virtually impossible for them to exit an investment position through the open market. See an earlier article here that addresses this topic in more detail.
This is a reprint of an article by Mr. Woessner published on December 12, 2018 by equities.com at this link.
Mr. Woessner mentors, advises, and helps raise capital for companies in the start-up and smaller-cap company ecosphere. He also advocates for policies to help smaller-cap companies access capital and for policies that create a more hospitable public company environment for them. For more information on Mr. Woessner’s background, see https://www.linkedin.com/in/ronald-woessner-3645041a/.
US public companies are disappearing! This trend is 100% opposite the trend in other developed countries with similar institutions and economic development.