Grant Thornton and the vanishing IPO market

I've been in the software industry for nearly 30 years at this point, most of the time in fairly small software companies. I've worked at multiple venture-funded companies, and been through an IPO. I mention this merely to substantiate the fact that I've been paying close attention to the venture-funded software industry, and to the role of the IPO in how the industry operates.

One of the massive changes in this industry over the last decade has been that the IPO as a vehicle for software company funding has essentially vanished. In the 1980's and 1990's there were hundreds of software company IPO's, but since the turn of the century those events basically don't occur anymore. Instead, what happens, so far as
I can tell, is that software companies are sold to large, established firms (Google, IBM, Microsoft, HP, Oracle, etc.).

I've wondered, for quite some time, about why this change occurred, but had never found very good information that explained it. People would sort-of wave their hands and blame "the economy", or "the dot-com bubble", or such similar nebulous explanations.

So I was fascinated, a few weeks ago, to stumble upon this fascinating analysis by the tax consulting firm Grant Thornton. In considerable detail, with analysis and explanation, the Grant Thornton paper shows why the IPO market vanished, and describes the effect that this has had on American industry.

It's no mystery to people who work in the venture capital industry that in order to drive returns for investors in their funds, they've monetized returns by seeking "liquidity events" away from the public markets. While there is an array of liquidity options -- including alternative listing venues, such as the NASDAQ Portal, the AIM (London) or the TSX (Canada) -- most of these options have their own limitations and satisfy only a small fraction of liquidity needs. As a result, most companies today never make it public. Instead, the exit workhorse of venture capital is now the sale of a portfolio company to mostly strategic (large corporate) acquirers.

The paper describes a "Perfect Storm" of changes:

The Great Depression in Listings was caused by a confluence of technological, legislative and regulatory events — termed The Great Delisting Machine — that started in 1996, before the 1997 peak year for U.S. listings.

These changes, including:

• Sarbanes-Oxley Act


• Gramm-Leach-Bliley Act


• online brokerages


• decimalization


• Order Handling Rules


• Regulation FD


• Regulation NMS

among others, together changed the conditions so that the IPO market that had existed in the 1980's and 1990's rapidly evaporated:

The United States enjoyed an ecosystem replete with institutional investors that were focused on the IPO market — active individual investors supported by stockbrokers and a cadre of renowned investment banks, including L.F. Rothschild & Company, Alex. Brown & Sons, Hambrecht & Quist, Robertson Stephens and Montgomery Securities, that supported the growth company markets for many years. None of these firms survives today. Firms have attempted to fill the void and have found that the economic model supported by equity research, sales and trading no longer works.

They make a persuasive argument that

this is not just an IPO problem. It is a severe dysfunction that affects the macroeconomy of the U.S. and that has grave consequences for current and future generations.

Of course, the authors have their own axe to grind; every analysis has its biases, and that's unavoidable.

Furthermore, we couldn't simply turn the clock back, and return to the economic and policy structures of the 1990's; the world has moved on.

Still, it's a very interesting argument, and if you're at all intrigued by these ideas, it's worth a read.