The Long-Term Harm of SOX and Other Regs, Part 1: Where ARE the Initial Public Offerings (IPOs)?

Spacetropic beat me to this extremely important op-ed (”The Pump-and-Dump Economy”) by Michael Malone of ABC News.com from the subscriber side of the Wall Street Journal last week — so important that I’m going to excerpt it pretty heavily.

It’s way past time that someone takes notice that of what Spacetropic properly calls the “grim new trend.” Something isn’t happening in this prosperous economy that normally would be:

Take the Dow industrials blowing past 12000, and the attendant stratospheric valuations of companies like Google and Apple. While it is a welcome rebuke to those who smugly proclaimed five years ago that the tech industry was being punished for its excesses and would never see such good times again — Silicon Valley and other tech enclaves are now more prosperous than ever — it is troubling to note that something is missing from this new boom: Where are the IPOs?

Historically, stock booms have seen an explosion in the number of young companies making their first public sale of stock.

….. by the end of the third quarter this year, only 37 companies had offered IPOs — a figure comparable to 2001, when the entire economy seemed to be coming apart. The shortfall doesn’t owe to a lack of entrepreneurial fervor. Venture capital funds are swollen with money right now. Nor is it a shortage of new companies …..

….. In the past, the inevitable end-point of these (start-up company business) plans, the so-called liquidation moment, was an IPO. Not any more. These days, the goal of almost every new start-up is to be acquired by an established company. And in that little shift in orientation lies a potentially radical change in the U.S. economy.

Why do young private companies want to sell out now instead of becoming public corporations?

….. Not least — but worst — there is the Sarbanes-Oxley Act of 2002, whose self-monitoring rules Big Corporate initially resisted, but now embraces as an effective way to track internal financial operations. That alone should make you suspicious, because when established businesses like new rules it’s usually because it makes them more competitive against start-ups.

….. The closer you look at Sarbanes-Oxley the more you realize it is almost perfectly designed to crush new business creation. The latest estimate for the annual cost of implementing Sarbox in a public corporation is $3.5 million. Pocket change for a Fortune 500 company; the entire annual profit of a newly public firm. Is it really any wonder that smart entrepreneurs look for a corporate sugar daddy instead of an IPO?

Which brings us to Google. One reason that few people have noticed the IPO dearth is that the one real initial public offering — Google’s legendary Going Public Day in August 2004 — was such a supernova that it blinded everyone to the changes taking place around it. Now rich and fat, Google has assumed a new role in the Silicon Valley ecology: buyer. The joke these days is that every new business plan has the same words on the last page: Sell to Google. That probably makes Chris Sacca, Google’s director of new business development, the most influential businessman in America today.

Google’s $1.65-billion acquisition of YouTube is emblematic of this shift.

In short order, former opponents of SOX (and the Big 4 accounting firms) appear to have made their peace with it. If this seems difficult to accept, think back to the 1960s and 1970s when the government began to exert regulatory force on the auto industry, then the near-exclusive province of the Big Three. Each successive regulation would be greeted with an almost-eager “yeah, we can do that” from behemoth General Motors (which only a few years earlier had bitterly fought Ralph Nader), a reluctant “OK, but we don’t like it” from Number 2 Ford, and screams from little-guy Chrysler.

Why? Because each successive government reg created new fixed costs that GM could spread over many times more vehicles than Chrysler could. Accepting regulations, even encouraging them, effectively became part of GM’s competitive strategy. And so it goes today with large corporations, the big accounting firms, and SOX.

The fact that fewer companies are going public is not only working to increase business concentration; it is also affecting how entrepreneurs are looking at their businesses from Day One of their founding — and not for the better. We’ll see how in Part 2, which if you are on the home page, follows immediately below.