September 29, 2016

How a Sputtering IPO Market Could Spawn a New Breed of Banker

A nighttime view on Wall Street. SMITH BRAIN TRUST – There's a sort of perfect storm that's battering initial public offerings this year, with cheap debt, market volatility, alternative capital providers and a more "millennial" entrepreneur all dampening the market for stock debuts. 

U.S. companies completed just 68 IPOs this year, as of mid-September, compared to 135 by the same point in 2015 and well behind 2014’s pace and total of 263. 

Alternative capital providers are big a reason for the slowdown, says finance professor Laurent Frésard at the University of Maryland’s Robert H. Smith School of Business. “Compared to 20 years ago, the private equity market is more developed, venture capitalists are abundant, and newer approaches like crowdfunding and peer-to-peer lending are a reality. The IPO market no longer is ‘only game in town’ to raise capital.”

Persistently low interest rates are another major factor. Some firms are deciding to borrow to fund their expansion plans, rather than paying  an investment-bank fee of 7 percent on the amount raised via IPO. 

Stock market volatility has some companies shying away from the trading floor, notes Liz Sara, chair of the Dingman Center for Entrepreneurship Board of Advisors at the Smith School. “Neiman Marcus, as one example, postponed their IPO last year for this very reason,” she says, noting general volatility and rough seas for luxury-goods stocks. “Basically, they felt it was too risky.”

For some firms, the disclosure requirements an IPO carries are a massive deterrent, says Frésard, “Many firms, especially in information-sensitive markets, do not want to disclose too much information.”

But maybe closer to the core of the IPO slowdown is the fact that deep-pocketed strategic buyers are targeting (predominantly millennial) technology founders who generally aren’t looking to get rich quick, says Sara, who teaches business-to-business marketing to Smith MBAs and has helped dozens of early-stage software companies get to market as founder of Best Marketing LLC. She is the first female chair of the Dingman board.

“These founders want their innovative, cloud-based app to become ubiquitous – and the de facto standard for automating, executing, delivering or doing whatever consumer or business function it addresses or simplifies,” she says.  

Basically, they want to be the next Facebook or Uber, and that’s what makes strategic buyers a natural fit, Sara says.  

“Becoming aligned with such a strategic acquirer not only provides the capital for national or global expansion to their target audience – which is the same audience as the acquirer, of course  – but also offers the credibility associated by being acquired by brands they admire and emulate in the first place,” she said.

And there are lots of mega-billion-dollar market cap companies out there shopping every day for cool stuff to acquire. “These companies simply did not exist 10 or 15 years ago,” Sara said.

But what about the traditionally accepted advantages to having an IPO? These include bolstered balance sheets plus public-market access that enhances flexibility for continuing growth, increased wherewithal for future expansion and increased awareness of a company’s products and-or services.  “While an IPO does raise a company’s visibility to the Wall Street community, using social media can easily trump that – across all communities of buyers,” Sara says. “Savvy marketing departments of companies in every vertical market know how important these channels are to winning over new business or consumers … or maintaining them.”

Life Imitating ‘Shark Tank’ 

An angel investor for six years, including with Dingman Center Angels, Sara hears pitches from about 100 companies a year, in a process she describes as similar to the TV show “Shark Tank,”  – albeit “with a lot less drama.” She says the startups she talks to aren’t thinking about IPOs as part of their futures. 

“It’s all about which companies would want to acquire them,” she says. “The tug of war between the founder and the investor is not about should you sell the company…but when.  That’s a whole separate subject.”

The Big Slump Prognosis 

Will the market shift to more IPOs anytime soon? “I don’t see it,” Sara says. “There’s a lot of outside capital available.” Plus, she adds, venture funding of startups has more than doubled in the U.S., from $4.75 billion in 2012 to $11.46 billion in 2015, according to PitchBook database of mergers and acquisitions, private equity and venture capital. So far this year, startups raised $6.26 billion, the database shows.

Frésard concurs: “In my view, [the shift from IPOs] is here to stay. But what is most important is that good ideas get financed,and this seems to be the case in the current, newly competitive environment.”

Sara says, “Big tech leaders still look to the small players for innovation and to round out their end-to-end enterprise solutions. More M&A activity will occur – not less. So, why bother with an IPO when there’s such market demand?”

New Breed of Financial Analyst Looms 

With the IPO market sputtering, investment banks' profits will surely take a hit, Frésard says. But firms finding it more attractive to grow while remaining private still need capital. This suggests a need for a new generation of analysts that can gather and process information that is not publicly available to value companies and new ventures.  “The set of skills is probably different that what traditional analysts have,” he says. “So, I see a good opportunity for banks to develop and nurture these skills, and potentially recapture part of the market for financing American growth.” 

More immediately, “unless banks can reallocate the human capital for other purposes (like M&As), job cuts will take place and bonuses will be under pressure,” Frésard says. “But  investment bank employment has historically been very responsive to cycles, so this is not a new phenomenon.”

On the bright side for financial-IPO specialists, Frésard adds, a reduced labor demand from investment banks stands to be countered “by more hiring by the alternative, and perhaps more efficient, capital  providers.”

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About the University of Maryland's Robert H. Smith School of Business

The Robert H. Smith School of Business is an internationally recognized leader in management education and research. One of 12 colleges and schools at the University of Maryland, College Park, the Smith School offers undergraduate, full-time and flex MBA, executive MBA, online MBA, business master’s, PhD and executive education programs, as well as outreach services to the corporate community. The school offers its degree, custom and certification programs in learning locations in North America and Asia.

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