TechPulse 360

Conventional wisdom says the IPO market is in a cyclical downturn made worse by the credit crisis pummeling the economy.

But a new darker view is emerging, according to a study by the auditing firm Grant Thornton. The IPO market is structurally damaged – and closed to 80 percent of the technology and other startups that need it for money to expand.

The result is slower economic growth in the U.S., fewer jobs created, and an environment where tomorrow’s corporate leaders have a tougher time growing to their potential.

The study argues that the time for a cyclical rebound has passed. The “U.S. economy, with an abundance of venture capital, should have produced over 500 IPOs every year for each of the last four years; however, this is not the reality,” the November study says.

IPOs are down sharply since 2001

Instead, with more than $440 billion of venture capital raised since 1996, only an average of 134 companies have gone public each year since the dot-com bubble burst in 2001. An annual average of 520 IPOs were launched during the five years before the 1996 to 2000 bubble and an average of 539 a year during the bubble.

To explain the change, Grant Thornton points to the advent of online trading in 1996, which led to a sharp cut in stock trading fees – to $25 or less a trade. The impact forced retail stockbrokers into the role of fee-based financial advisors, and in doing so killed “the very best stock marketing engine the world had ever known,” the study says.

With lower trading fees, Wall Street firms were unable to conduct as much stock research as before – especially into smaller, just-public companies. Cheap fees also encouraged speculative short-term trading at the expense of long-term investing, among professional as well as retail investors.

The study downplays the role of Sarbanes-Oxley, which is often cited for the IPO decline. The 2002 law did increase costs and lengthen the time it takes for companies to go public, but it is only one factor and probably not the major factor, the study says.

With the IPO market on the sidelines, most “liquidity exits” for startups have been mergers and acquisitions, frequently with large corporate buyers. Instead of giving some of these young companies that chance to bloom into large, independent, public companies, “big corporations are eating our young as (these startups) starve for capital before they have the opportunity to reach adulthood,” the study says. “Their true potential will never be known.”

The secondary impact is to make VCs less reluctant to fund companies that don’t have an obvious Fortune 500 buyer. “Gone are the days when most venture capitalists would so willingly pioneer new industries and technologies (e.g.: semiconductors, computers and biotechnology) that have no obvious outlet other than the IPO market,” the study says.