Why Can't Small Companies Go Public These Days?

There's been no shortage of Important Discussion recently on the subject of what a panel this afternoon grandly called America’s Global Competitiveness. Up on stage were Hal Scott, of the Committee on Capital Markets Regulation, and Arthur Culvahouse, of the even more grandly-named Commission on the Regulation of US Capital Markets in the 21st Century. Naturally, they talked of McKinsey's Bloomberg-Schumer report (pdf) as well. What made the panel more interesting than most was the presence of Michael Oxley himself, architect of the loathed Sarbanes-Oxley Act. But the star of the show was actually the Carlyle Group's Robert Grady, who seemed to mainly be wearing his hat as chairman of the National Venture Capital Association.

Grady was reasonably polite about Sarbox: It's not the act in general that he doesn't like, just its section 404. What he and the panel were much less happy about was the rise in what you might call lawyer-related expenses. Venture capitalists used to be able to exit into the stock market even when the companies concerned had tiny market caps: when Intel went public the entire company was worth just $53 million, and when Cisco went public it was worth only about $250 million. "None of those three deals would be doable today, bc there's too much friction in the small-cap offering process," said Grady.

It turns out that the quantity of IPOs these days isn't just low in relation to the boom years of the late 90s. It's also low in relation to the bust years of the early 90s. Nowadays, the overwhelming majority of venture-capital exits are in the cost-heavy M&A market, which says a lot about the cost of exiting into the public stock market.

In any case, says Grady, if you're a small-cap stock listed on the Nasdaq market, you might as well be a private company for all the public coverage you get. Fully 60% of the companies listed on Nasdaq have either zero or one analyst covering them, which means that those stocks simply don't have most of the advantages of being public.

Grady has many non-Sarbox targets he blames for this state of affairs: stock-market decimalization removed Nasdaq broker-dealers' profits and therefore their incentive to provide stock coverage; Eliot Spitzer's research settlement also took analysts out of the sell-side and into the world of hedge funds.

I'm not sure that it's a lack of research coverage that is preventing small companies from going public. Maybe much of the reason is simply that they're worth more if sold privately. But there's no doubt that regulatory and compliance costs would make any company think twice about a US listing.