One week this summer, the Nasdaq stock market listed five recent initial public offerings, including Sonos, the home-audio company, and Vaccinex, which makes a promising cancer drug. That same week, an investor looking at Nasdaq’s Listing Center would have seen the names of 16 stocks set to disappear. The reasons for the delistings varied. Synchronoss Technologies, a software company, had failed to file financial reports since February 2017. Abaxis, a veterinary-diagnostics firm, was being acquired by Zoetis. Capella Education was merging with Strayer Education (both operate for-profit schools).
The week was representative of the past two decades. In 1997, during the dot-com boom, there were 8,884 companies listed on U.S. exchanges, primarily on Nasdaq and the New York Stock Exchange. Since then, the number has been cut by more than half. The pace of decline has been gradual, unaffected by the dot-com bust, the financial crisis, or subsequent recoveries. A two-decade chart showing the number of public companies looks like a slide at a children’s playground, slowly but surely going down.
Should we be concerned? Stock-exchange officials certainly are. Last year, Thomas Farley, then the head of the NYSE Group, said the drop “may severely limit [companies’ opportunities] for economic growth, hiring, and wealth creation.” Earlier this year, in her introduction to a white paper, Nasdaq’s CEO, Adena Friedman, warned that if the trend continues, “job creation and economic growth could suffer, and income inequality could worsen as average investors become increasingly shut out of the most attractive offerings.”
Of course, Farley and Friedman have a financial stake in the health of the exchanges. But there is a broader logic to their professed concerns. Traditionally, promising young companies turned to the public markets to raise capital in order to expand their operations; this gave individual investors a shot at owning a piece of those companies’ hoped-for success, either by buying their stocks directly or, more commonly, by holding them in a mutual fund or index fund. Today, more and more start-up companies secure funding from private investors, cutting most Americans out of the equation.
Robert J. Jackson Jr., a commissioner of the Securities and Exchange Commission who previously worked at Bear Stearns underwriting IPOs, told me there can be real distributive consequences when the highest-growth companies are private. If many of the economy’s greatest success stories aren’t included in the funds that ordinary Americans hold, only the wealthiest members of society will enjoy the gains, intensifying inequality. “It’s a good enough argument for me to care about wanting more companies to be public,” Jackson said. SEC Chair Jay Clayton agrees. In his first major speech, he warned: “The potential lasting effects of such an outcome to the economy and society are, in two words, not good.”
The initial public offering was once the ultimate marker of start-up success. Founders of a company might get their idea off the ground by asking family members and friends for seed money, then turn to angel funders, venture capitalists, and private-equity investors to keep the lights on during the fledgling years. But the goal was typically an IPO. Historically, private investors have been willing to risk only relatively small amounts with any one company, and they have tended to exit any investment within a few years. The IPO gave a thriving company a base of capital and announced to the world that it had arrived. Throughout the 20th century, one of the most revered symbols of a mature business was the framed ceremonial gavel its managers had used to ring the New York Stock Exchange bell.
An IPO is still the best means for many companies to obtain liquidity; selling shares on a public exchange remains easier and cheaper than in the private markets. But staying private has, for a variety of reasons, become more alluring than it used to be.
Going public is expensive. Investment bankers, lawyers, and auditors collectively charge millions of dollars to prepare the lengthy registration statement that must be filed with the SEC before shares can be sold. And that’s just the beginning. It costs millions more to comply with ongoing-disclosure requirements. Public companies also incur the harder-to-quantify costs of opening their books to the scrutiny of securities analysts, activist investors, the media, and short sellers. Equitable Financial, a Nebraska bank operator that delisted from Nasdaq this summer, said it was doing so in order “to eliminate the administrative and annual fees associated with being listed on Nasdaq.”
The steady deregulation of private markets is at least as important a factor as the high costs of going—and staying—public. For decades, because of securities laws passed in the wake of the Great Depression, firms could raise only small amounts of money without triggering public-reporting requirements. But the National Securities Markets Improvement Act of 1996 made it easier for private companies to sell stock to “qualified purchasers,” meaning large institutions and wealthy investors. In 2012, Congress increased the allowed number of investors in large private firms from 500 to 2,000. The SEC, meanwhile, adopted rules that encouraged “private placements,” which permitted private firms to raise millions of dollars while avoiding public reporting. Today, some in Congress and at the SEC fret about the size and influence of private markets, but they are at least partly responsible for those markets’ rapid growth.
Private assets under management totaled less than $1 trillion in 2000; they surpassed $5 trillion last year. In this climate, many companies no longer need an IPO to raise capital. When a handful of start-ups recently began putting rental scooters and bikes at strategic points in urban areas, the idea quickly spread, and hundreds of millions of dollars of private money soon followed. Bird, Lime, and Spin didn’t need an IPO; there was plenty of private cash to go around.
The shrinking of public markets has undoubtedly altered the playing field for average investors, but it is important to be precise about how. The total number of public companies is much lower today than during the 1990s, but the total value of public companies has increased. Jay Ritter, a finance professor at the University of Florida, is widely regarded as the leading scholar studying IPOs. When I asked him about the sharp decline in public companies, he was surprisingly sanguine. Ritter isn’t especially concerned about the growth of private markets, or even the decline in IPOs. Instead, he says the most significant change is that both public and private companies are bigger, mainly because technology is reducing costs and creating incentives to scale.
Consider Alphabet, Google’s parent company, which has spent tens of billions of dollars buying hundreds of other companies, sometimes at a rate of one acquisition a week. Before the 1990s, many of these acquired companies—Android, Waze, YouTube—would have gone public on their own rather than accepting an offer from an industry giant. But today almost 90 percent of venture-capital-backed firms seek to be acquired. In this sense, publicly traded companies aren’t really disappearing; they are consolidating. The phenomenon isn’t limited to the tech giants; other large public companies, including Anheuser-Busch InBev, General Electric, and Procter & Gamble, are also growing larger and more acquisitive. Coca-Cola has spent billions buying a range of businesses recently, including Costa Coffee, the U.K.-based chain, and several Latin American beverage sellers.
What does it mean for the average investor to own bigger stocks? Instead of buying stock in a collection of separate public companies, when you buy a share of Alphabet or Coca-Cola, you get many businesses wrapped up in one big package. You can’t always get detailed information about the performance of subsidiaries and divisions; if you own shares in those big companies, you just have to hope that the component parts are profitable and that their profits flow through to the parent company’s bottom line.
Still, buying big public companies is becoming a sure way to buy lots of small private ones. Many large public companies—including Intel, Johnson & Johnson, and Time Warner—have divisions that are explicitly tasked with investing in and sometimes acquiring private companies (some invest in public companies, too). When SoftBank Group, a Japanese conglomerate, created its Vision Fund last year to invest in technology companies, both private and public, some of the fund’s $100 billion came from Apple and Qualcomm.
All of this consolidation does pose challenges for investors. Traditionally, small stocks have delivered both higher risk and higher returns; if you own shares in an index fund, consolidation means you have less exposure to small stocks than in the past. If you want that exposure, you probably need to rejigger which funds you own. An SEC rule permits mutual funds to invest up to 15 percent of their assets in private companies, and more are doing so, although most actively traded funds remain below that limit. As of July, the 12th-largest investment in the $25 billion–plus Fidelity Blue Chip Growth Fund—behind Tesla and Home Depot but ahead of Mastercard and Netflix—was a $438 million stake in Juul, the private company behind the wildly popular vaping device.
The ways in which average investors can participate in the private market are imperfect. Unless you are very wealthy or well connected, you probably are not going to be buying into the leading venture-capital funds, such as Andreessen Horowitz and Sequoia Capital. We should be wary, however, of accepting a romantic notion of the past in which Wall Street was a level playing field for individual investors. When I was at Morgan Stanley in the 1990s, the bank’s senior employees had special access to a private-equity partnership called Princes Gate, which made early-stage investments in companies like Au Bon Pain and Cannondale and generated 30 percent–plus annual returns. Average investors were not invited. The markets have always been split, in some ways, between haves and have-nots.
As for public markets, there are responsible ways to encourage small-company IPOs. In July, lawmakers in the House of Representatives introduced a proposal to study the problem of high IPO fees for companies with less than $1 billion in revenue. Bigger companies can negotiate lower underwriting fees; Facebook, for instance, paid a 1.1 percent fee, whereas most smaller companies pay 7 percent. SEC Commissioner Jackson labels these high fees a “middle-market tax,” which deters small and midsize companies from going public. He’s called on investment bankers to price IPO fees more competitively. “We’ll be watching,” he told me.
But let’s not fall back into the trap of viewing an IPO as good in and of itself. IPOs are often poor investments; one reason we see fewer of them today is that many investors were burned by dot-com companies that promised riches and then collapsed.
It’s a lesson worth remembering, even as the action in the economy continues its shift from public to private markets. In late August, Jay Clayton announced that the SEC was working on adjusting the current rules to make it easier for average investors to take part in private investment. But the existing barriers were put in place for a reason: They make it harder for closely held companies to take advantage of unsophisticated investors. Before buying a piece of that private purveyor of celery soda, consider an alternative that might give you similar exposure, and less risk: a good old-fashioned share of Coca-Cola.
This article appears in the November 2018 print edition with the headline “Private Inequity.”