Many pundits sneered about Facebook's less-than-stellar initial public offering (IPO) in its first week, but the bottom line is that such efforts raise the capital needed to increase sales and boost employment. Now, a new study confirms that IPOs promote growth, but sounds a warning about a precipitous drop-off in IPOs in recent years.
The Kauffman Foundation's study asserts that nearly 1.9 million new jobs have been forfeited in the past decade due to a diminished number of IPOs.
According to the report, Post-IPO Employment and Revenue Growth for U.S. IPOs, June 1996-2010, the volume of IPOs fell nearly 70% in the past decade from the average volume in the prior two decades. This drop – from an average of 298 domestic US operating companies per year during 1980-2000 to an average of only 90 per year during 2001-2011 – was even more pronounced among small companies.
Not clear from the report are the reasons for the drop-off in IPOs. Economic conditions may be part of the blame, as the economic slump that began in 2007-2008 -- along with roller-coaster stock prices -- scared away many entrepreneurs and companies contemplating this route.
Also, the rise of regulations and mandates, such as the Sarbanes-Oxley Act -- which strictly dictates the reporting requirements of publicly traded companies -- may cause many small to medium-size business owners to prefer to remain the private-equity sphere.
There are also alternative routes of business funding that also may further dampen IPO activity in the future. For example, crowdfunding is now a legally viable means to raise capital through social networks. With the growth of cloud computing, many smaller businesses can get off the ground and start operations with minimal infrastructure investments.
Still, as the Kauffman study's authors point out, the plunge in IPOs during the past decade is of concern because fast-growing entrepreneurial firms create the nation's most significant employment, and, for these young companies, IPOs long have been considered important for raising capital to fuel continued growth. This in turn has put a damper on employment. "Startup companies are almost solely the catalysts for job growth," says Robert Litan, vice president of research and policy at the Kauffman Foundation. "It is important to understand the extent to which highly successful startups – those that are able and willing to access the capital markets to finance their growth – expand their revenue and employment once they do go public."
The study calculates that the 2,766 companies that went public in the United States from June 1996 through 2010 employed 5.062 million people prior to their IPOs and 7.334 million in 2010, a 45% increase. That's an additional 822 jobs per company after their IPOs.
Sales after IPOs also increased 96%, from $1.32 trillion in the year before going public to $2.58 trillion in fiscal 2010.
Using these numbers, the report's authors calculate that, had the number of 1980-2000 IPOs been maintained during 2001-2011, the 2,288 additional IPOs would have created 1.881 million more jobs.
Emerging growth companies, defined as domestic operating companies less than 30 years old that are not spinoffs, rollups, buyouts or demutualizations, account for 1,700 of the 2,766 companies that went public during the study period. The emerging growth sector's post-IPO employment increased 156%, and inflation-adjusted sales jumped 259%, representing far faster growth than the 1,066 other IPOs, which increased employment by 29% and revenue by 78%.
Employment grew rapidly for the 1996-2000 cohorts. Significant post-IPO growth continued for cohorts that had IPOs after 2000, though at a much more subdued pace. After 2000, only the 2004 cohort, which included Google, Salesforce.com and Texas Roadhouse, grew dramatically.
Among emerging growth companies that made IPOs from 1996 through 2000, only 29% were still operating 10 years later. That's because most, 55% were acquired by larger firms. About 16% failed, the study finds. And, despite perceptions about a large number of failures of the dot-com era, acquisition is a far more likely outcome than outright failure for all cohorts. "The fate of most Internet firms, as is the case of software and other information technology sectors, was acquisition."
Biomedical IPOs had the highest survival and lowest bankruptcy rates among all sectors; the highest failure rates were in manufacturing and retail.
(Photo Credit: Sarah Tew/CNET.)