The Rise and Fall of the IPO Market
Simply put, an IPO stands for Initial Public Offering: a privately owned company lists its shares on the stock exchange. The public can then buy shares and possess ownership in the company. It is a way for a private company to raise capital beyond its own ability to self-finance through cash from normal business operations, which can fund R&D, new employment, real asset accumulation, and debt reduction (Hunsaker, 2017).
To begin the IPO process, private companies planning an IPO have to file paperwork with the Securities and Exchange Commission, which is responsible for overseeing and regulating the securities markets to protect investors and maintain order and fairness in capital formation (Ashford, 2021). The company usually hires multiple underwriters—typically one or more investment banks—that negotiate and market the sale of its stock by selling the company stock to a larger pool of investors in the public markets (Jagersen, 2017). These underwriters also create key documents for investors and schedule roadshows to distribute new IPO shares. When the company and the underwriters have determined an initial price for shares in the stock, the underwriter begins issuing shares on a public stock exchange.
IPOs saw a large increase in 2020 and 2021 due to monetary easing policies and the stock market rising in 2021 but particularly due to the rise of special purpose acquisition companies, or SPACs. These companies are specifically designed with no commercial operations and exist solely for the purpose of raising capital and identifying a merging target. Once the SPAC goes public, it searches and ‘acquires’ a targeted, operating, private company. Through 2021, the United States saw 2,388 deals which raised $435.3 billion in proceeds, which was a 64% and 67% increase year-over-year (Gerring et al., 2021). Despite monetary easing policies during the pandemic, heightened optimism for vaccinations and reopening of many industries, no single aspect played a bigger role than SPAC listings in the booming IPO market; SPACs represented over 59% of total new listings in 2021 (Mackintosh, 2022).
SPACs offer multiple advantages for small, private companies over a traditional IPO. Because SPAC mergers need to list, raise capital, and merge with a target company within 18-24 months, the process is much faster than a traditional IPO (Roussanov, 2021). Furthermore, if a suitable target company is not found, a SPAC’s investment can be liquidated and returned to stakeholders, offering security through cash raised in the IPO (“What Is a SPAC?”). In the face of public scrutiny once a private company goes public, the SPAC route offers a pre-revenue, capital-hungry, young firm the opportunity to capitalize on short, volatile market windows and fulfill lower disclosure requirements compared to a traditional IPO (Roussanov, 2021). SPACs, unlike IPOs, are typically set up by venture capitalists and private equity firms that have industry expertise and a network of contacts, utilizing operational expertise. And in the context of newfound developments in biotechnology, cloud-computing, and consumer markets, SPACs provide younger, more speculative companies with greater fundraising opportunities that would typically be unavailable due to enormous capital requirements. With the increase in serious investors launching and sponsoring SPACs, including the aforementioned established hedge funds, private-equity and venture firms, the SPAC route has provided a quick, less costly avenue for private investors with excess cash to meet start-ups in search of liquidity and capital (Bazerman and Patel, 2021)
But, underneath the glut of SPACs in equity capital markets, the products of these ventures have largely yielded mediocre returns for investors. More than 60% of IPOs between 1975 and 2011 saw negative absolute returns after five years, and a similar pattern is occurring today within the IPO market—particularly in the tech sector (Ashford and Schimidt, 2021). For example, the tech-heavy Nasdaq index ended almost 9% lower at the end of January than it did at the beginning. Private technology companies with little profits have been at the brunt of the IPO slowdown—largely because market capitalization and predicted cash flows must be reevaluated in the wake of multiple economic factors. These factors include high anticipated IPO supply, anticipation of higher Federal Funds rates amid increasing inflation, and most importantly, a 75% rise in CBOE Volatility Index (VIX) likely due to the Russian invasion of Ukraine (Wang, 2022). In the wake of declining performance, the likelihood of the SPAC market retaining its activity is low. The Securities and Exchange Commission has begun cracking down on SPACs, criticizing the outlandish valuations and lack of financial disclosure promoted by the pandemic’s money-filled, low interest market. The SEC proposed a set of measures to align SPAC financial projections closer to traditional IPOs, citing concerns about “unreasonable, unfounded or potentially misleading [projections]” (Ponciano, 2022). Additionally, enhanced disclosures in conflicts of interest, SPAC sponsors, and dilution all point to a plunge in activity.
Market volatility spells bad news for both investors and companies looking to go public. Company executives strive to go public in a bullish market, where they can receive the highest possible valuation and largest sum of cash when selling their company. Similarly, investors typically entertain issues of new stocks only if they are confident about the economy (Krantz, 2011). Over the next few months, financing costs are expected to rise due to volatility, since the risk premiums needed for investors skyrocket. Because of this, many U.S. companies have put the brakes on planned IPO transactions, pulling equity-capital-markets transactions valued at $1.17 billion in February, a 234% increase in withdrawn capital (Trentmann, 2022).
In an uncertain market, investors have begun to look to safer investments—particularly the bond market. U.S. Treasury Yields rose amid developments in the Russia-Ukraine crisis and expected increases by the Federal Reserve to the interest rate. When interest rates go up, new bonds issued by the federal government come with a higher rate and provide more income. In addition, these bonds are backed by the ‘full faith and credit’ of the U.S. government, meaning these bonds are backed by the government’s ability to collect taxes and other revenues. This is typically a safe investment since the government has theoretically unlimited capacity to collect revenue. As a result, investors’ fears of interest rate hikes and need for low-risk investments have driven up the yield on the benchmark 10-year Treasury Note, increasing since the invasion on February 24th and recently surging 9 basis points on March 8th (Fitzgerald & McKeever, 2022). While unprecedented stimulus measures fueled a boom in global equities during the pandemic, capital markets have done a complete 180 with central banks raising interest rates due to investor fears fueled by inflation and geopolitical conflict. As investor enthusiasm and risk tolerance wanes, so too does capital diverted to public offerings, which instead moves toward safer investments (Fioretti and Gopinath, 2022).
The outlook is not all negative, however. IPOs and SPACs have been booming in the Middle East due to rising oil prices and interest rates. Major commodity markets are trading at record highs from supply chain bottlenecks due to COVID-19 and geopolitical conflict (Fioretti and Gopinath, 2022). Bankers are betting on a transition to a better equity capital market environment as big name private companies are in the pipeline to go public. However, right now, the best bet for both private companies looking to go public and public investors interested in investing is to wait for a stronger IPO environment. The ongoing, geopolitical and economic turmoil strongly suggests even well-established startups should stay private to hopefully receive additional funding and better valuations in the future (Kunthara, 2022).
References
Ashford, Kate. “What Is an IPO?” Edited by Schmidt John, Forbes, Forbes Magazine, 10 Dec. 2021, https://www.forbes.com/advisor/investing/initial-public-offering-what-is-an-ipo/.
Bazerman, Max H, and Paresh Patel. “Spacs: What You Need To Know.” Harvard Business Review, 15 June 2021, https://hbr.org/2021/07/spacs-what-you-need-to-know.
Fioretti, Julia, and Swetha Gopinath. “IPO Market Plunges 70% as Higher Rates, War Curb Risk Appetite.” Bloomberg.com, Bloomberg, 26 Mar. 2022, https://www.bloomberg.com/news/articles/2022-03-26/ipo-market-plunges-70-as-higher-rates-war-curb-risk-appetite.
Fitzgerald, Maggie, and Vicky McKeever. “Treasury Yields Jump as Inflation Fears Rise.” CNBC, CNBC, 8 Mar. 2022, https://www.cnbc.com/2022/03/08/us-bonds-treasury-yields-jump-as-inflation-fears-rise.html.
Gerring, Rachel, et al. “2021 EY Global IPO Trends Report.” EY US - Home, EY, 16 Dec. 2021, https://www.ey.com/en_gl/ipo/trends.
Hunsaker, Morgan. “IPO Advantages and Disadvantages.” IPOhub, 12 Mar. 2022, https://www.ipohub.org/ipo-advantages-disadvantages/.
Jagerson, John. “How Does an IPO Work?” Learning Markets, 31 July 2017, https://www.learningmarkets.com/how-does-an-ipo-work/.
Krantz, Matt. “Volatile Market Has Been Bad News for IPOs.” ABC News, ABC News Network, 1 Sept. 2011, https://abcnews.go.com/Business/volatile-market-bad-news-ipos/story?id=14432204.
Kunthara, Sophia. “The Market Minute: Public Market Turmoil Could Upend Game for Late-Stage Startups.” Crunchbase News, 3 Feb. 2022, https://news.crunchbase.com/news/public-market-turmoil-ipo-valuations-investors-startups/.
Li, Yun. “Record IPO Rush of 2021 Led to Historically Dismal Returns for Investors with No Relief in Sight.” CNBC, CNBC, 20 Jan. 2022, https://www.cnbc.com/2022/01/20/record-ipo-rush-of-2021-led-to-historically-dismal-returns-for-investors-with-no-relief-insight.html#:~:text=Delivering%20Alpha-,Record%20IPO%20rush%20of%202021%20led%20to%20historically%20dismal%20returns,with%20n%20relief%20in%20sight&text=A%20Rivian%20R1T%20electric%20pickup,10%2C%202021.Mackintosh, Phil. “A Record Pace for SPACS in 2021.” Nasdaq, NASDAQ, 6 Jan. 2022, https://www.nasdaq.com/articles/a-record-pace-for-spacs-in-2021.
Ponciano, Jonathan. “SEC Unveils New SPAC Rules Targeting 'Unreasonable' Financial Projections and Requiring More Disclosures.” Forbes, Forbes Magazine, 1 Apr. 2022, https://www.forbes.com/sites/jonathanponciano/2022/03/30/sec-unveils-new-spac-rules-targeting-unreasonable-financial-projections-and-requiring-more-disclosures/?sh=3b34bf4574dd.
Roussanov, Nikolai. “Why SPACs Are Booming.” Knowledge@Wharton, Wharton School of University of Pennsylvania, 4 May 2021, https://knowledge.wharton.upenn.edu/article/why-spacs-are-booming/.
Trentmann, Nina. “Companies Scrap IPOs Amid Russian Invasion of Ukraine.” The Wall Street Journal, Dow Jones & Company, 4 Mar. 2022,https://www.wsj.com/articles/companies-scrap-ipos-amid-russian-invasion-of-ukraine-11646389980.
Wang, Echo. “Analysis: U.S. IPO Slowdown Slams Door on Tech Unicorns Looking to Cash Out.” Reuters, Thomson Reuters, 3 Feb. 2022, https://www.reuters.com/technology/us-ipo-slowdown-slams-door-tech-unicorns-looking-cash-out-2022-02-03/.
“What Is a SPAC and Why Are They Suddenly so Popular?” Excelsior Capital, 30 Dec. 2021, https://www.excelsiorgp.com/resources/what-is-a-spac-and-why-are-they-suddenly-so-popular/.