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Is Going Public Going Out of Style?

The number of publicly traded companies continues to decline.
Alix Stuart, CFO Magazine
May 1, 2011

No matter how you slice it, the number of publicly traded companies in the United States continues to fall. On the major exchanges, there were 5,091 companies, including foreign-based ones, listed at the end of February, a 2% drop from 2009 and a 42% decline from the peak of 8,823 in 1997, according to new data from Grant Thornton. Looking across all U.S. exchanges, including the over-the-counter (OTC) market, the number of U.S.-based companies has fallen more than 30% since 2000, according to Audit Analytics.

Exactly why the number of publicly traded companies is declining is a matter of debate. Are the markets shunning companies, or are companies veering toward alternatives that don't require onerous reporting and disclosure requirements?

Companies have been disappearing from U.S. exchanges in various ways. About 140 companies left the public markets in 2010 through going-private transactions, according to FactSet MergerStat research. Those transactions, which hit a peak of about 200 per year in 2006 and 2007, included private-equity buyouts, management buyouts, and acquisitions of public companies by private companies. However, since many of those companies will subsequently go public again, experts say they don't account for much of the decline.

Other companies — approximately 375, according to CapitalIQ — were swallowed up by public companies through mergers and acquisitions. And about 100 companies were delisted from Nasdaq and the New York Stock Exchange in 2010 for being out of compliance with exchange standards, such as minimum trading prices.

At the same time, the number of IPOs has not been sufficient to replace the outflow. The swell of offerings in 2010 — 153 in total, up from 61 in 2009 — certainly helped stem some erosion. But Grant Thornton calculates that it would take more than 500 IPOs per year to grow the number of companies, and 360 just to replace delistings, volumes that are unlikely ever to occur, say Edward Kim and David Weild, senior advisers to Grant Thornton.

Fewer small companies are tapping the public markets.

The cost of being a public company — namely, the price of complying with Sarbanes-Oxley — is often tagged as the most significant deterrent to companies considering the public markets. Besides the organizational processes that must be put in place to comply, the cost of an audit can shoot up drastically once a company goes public. In part because public companies tend to be larger and more complex, the average public-company audit cost $4.8 million and consumed 21,458 hours, compared with $291,200 and 2,606 hours for a private company, according to a survey of 2009 fees by Financial Executives International.

However, there is little clear evidence that Sarbox is the true culprit. On one hand, about 11% of the companies that filed to go public between January 2009 and March 2011 withdrew from the process, with many citing the cost of going and being public as the main deterrent, according to a Securities and Exchange Commission analysis.

On the other hand, companies backed by venture-capital and private-equity firms, which make up the majority of IPOs, typically run their accounting and compliance processes as if they were already public. "You don't build it to sell it, you build it to be a standalone entity and operate on a quarterly cadence from day one," said Tim Healy, CEO of EnerNoc, at a recent conference. EnerNoc, initially venture-backed, raised close to $100 million when it went public in 2007.

"Food for Goldman"
Kim and Weild contend that the main reason behind the decline is that markets have become inhospitable to smaller private companies looking to raise less than $50 million. They see a stream of causes related to lower trading fees, stemming first from online brokerages and new order-handling rules in the late 1990s, and then from decimalization, which reduces bid-ask spreads. All of those factors reduce banks' potential profits from a company's stock activity. The global research analyst settlement separating research from banking has also contributed to the erosion of profit margins for banks.

Audit opinions by fiscal year show a notable decline.

Given those conditions, it no longer makes sense for investment banks to support small-company IPOs with capital and research, say Kim and Weild. Small companies "are not a product anymore; they're just food for Goldman Sachs's real clients" — hedge funds looking for quick gains through IPOs, asserts Kim. With such a large universe of companies shut out, he expects the pool of publicly traded companies to continue to shrink.

The decline means it will be harder for companies to grow, Kim says; it also weakens the capital-raising reputation of the United States against its global peers. Stock exchanges in virtually every other country continue to grow, particularly in China. A recent report from the Committee on Capital Markets shows that U.S. exchanges won only 14.2% of all IPOs last year, down from 16.9% in 2009 and an average of 28.7% between 1996 and 2006.


Indeed, venture capitalists now look at $100 million as the minimum revenue threshold for an IPO, says Mark Heesen, chairman of the National Venture Capital Association. With that as the target, he says, "VCs have to invest longer and spend more time on companies that are later stage, so they have less time and money to put in companies that are earlier stage."

On the flip side, some venture capitalists are coming around to the idea that an IPO "isn't the brass ring it once was," Heesen says, and prefer the certainty and speed of a sale rather than a public offering. "I would much rather sell a company for the certainty of cash these days than go public, because [with the latter]…you may be locked up into something that looks like a falling knife," says Michael Greeley, founder and general partner of venture-capital firm Flybridge Capital Partners.

Either way, the issue has attracted no shortage of attention in Washington, D.C. Treasury Secretary Timothy Geithner held a conference in March to examine the difficulty of funding for smaller businesses. Among other ways to improve liquidity, the Treasury Department is looking to put $1.5 billion in the hands of state officials to stimulate lending through partnerships with private lenders in the State Small Business Credit Initiative. (That may strike some companies as curious, given states' effort to claw back economic-development funds (see "States Show Their Claws").)

SEC chair Mary Schapiro also recently revealed that the regulator is taking "a fresh look" at ways to make small-business capital-raising easier. In an April 6 letter responding to questions from Rep. Darrell Issa (R–Calif.), head of the House Committee on Oversight and Government Reform, Schapiro noted that she had directed staff to study the possibility of expanding exemptions and sanctioning new capital-raising methods like crowd-funding for emerging businesses.

Capital By Other Means
Another effort to aid small companies that want to approach the public markets is the Small Company Capital Formation Act of 2011, sponsored by Rep. David Schweikert (R–Ariz.). That bill would increase the amount of money companies can raise in the public markets through Regulation A transactions from $5 million to $50 million. (Reg A allows companies to trade securities on the OTC market without having to register with the SEC, file regular reports, or be audited.)

The idea is that the additional capital could help companies grow without the costs of being public, allowing them to get big enough for major exchanges faster. Last year Nasdaq saw 54 companies upgrade from the OTC market to its exchanges, according to the market's 10-K, an uptick from 47 in 2009 and 45 in 2008.

Raising the limit "would be a positive step that would reduce some red tape, and one that I think Congress will pass, but it's just one step of many that would be needed," says Kim. "I truly believe that without a completely different market model, we won't fix these problems."

Alix Stuart is CFO's senior editor for small and medium business.


The drop in IPO volume has many possible causes.


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