Let's not go there.

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No '90s Nostalgia in Today's IPOs

Justin Fox is a Bloomberg View columnist. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”
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Of the 206 companies that had initial public offerings in the U.S. in 2014, 71 percent had no profits in the year before their IPOs. This is the highest percentage since the dot-com era, leading CNN Money to declare this week that the “ghosts of the late 1990s are back.”

The numbers, assembled every year by Jay R. Ritter, a finance professor at the University of Florida, do indeed show a willingness among investors to buy shares of companies that are losing money.

What the chart also shows is that a shift occurred in the late 1990s. Since 1996 or so, IPOs investors have -- except in the depths of the Great Recession -- been willing to buy into money-losing companies in a way that they weren't before. But most other things about today’s IPO market don’t resemble the 1990s at all. For one thing, there aren’t nearly as many companies going public.

Even the recent rise in IPOs is a little misleading, given that it's due mainly to an unprecedented boom in biotech IPOs. There were 74 of those in 2014, by Ritter's accounting, an all-time record (the previous high was 56, in 2000). Tech IPOs, meanwhile, are merely back to the level that prevailed from 2004 through 2007.

Biotech IPOs are still IPOs as you might imagine them from the late 1990s. Small company with no revenue but lots of promise goes public to raise the money it needs to bring its product to market. It's interesting that so many have been going public, and it's a big deal for the pharmaceutical industry. It doesn't have much to do with what's going on in the rest of the IPO market, though.

In the rest of the IPO market, companies are waiting longer to go public. They're much bigger and better established than the startups that flooded markets in 1999 and 2000 (and the 2013 and 2014 numbers were dragged down by all those zero-revenue biotechs).

Weirdest of all for those who still think of IPOs in 1990s terms, most companies that go public these days aren't really doing it for the money. "IPOs have now become first and foremost an exit event, secondarily a branding event and thirdly a funding event," says venture capitalist Tony Tjan of Boston's Cue Ball Capital. Tjan explains -- and this isn't exactly breaking news -- that this is because companies can raise much more money in private markets than was possible 15 years ago.

For an example of that, look at cloud storage rivals Box and Dropbox. Box went public last month in an IPO that raised $175 million. Before that it had raised $559 million from private sources, according to CrunchBase, bringing the total to $734 million. Dropbox is still private, and it has raised $1.1 billion. This also helps explain why so many of these companies (Box among them) have negative net income when they go public. They're not the spluttering startups of 1999 or 2000. They're already-somewhat-established companies spending the huge sums that venture capitalists and other private investors have given them in an attempt to grow quickly into giants.

This imperative to become huge is what's driving most of the changes in IPOs and the startup business in general, Ritter thinks. In the 2013 paper "Where Have All the IPOs Gone?" (I can't link to it directly, but you can download it from Ritter's Website), he and co-authors Xiaohui Gao and Zhongyan Zhu argued that the long decline in IPOs is the result not of rising regulatory burdens or changes in financial markets (the two most popular explanations) but of a winner-take-all dynamic at work in the economy. Businesses are getting bigger; small companies are finding it harder to get by. "No matter how much the regulations change, we’re not going to have lots of small companies going public like in the 1980s or 1990s," Ritter says.

One dramatic illustration of this is what happens to the businesses that get venture-capital investments. In the 1980s and 1990s, most recipients of VC funding went public. Now the vast majority are sold to other, bigger companies.

All this is of a piece with recent research by economists showing a decline in business dynamism in the U.S., with more concentration and fewer startups. Ritter thinks similar forces have been behind the rise in income inequality. Technology and globalization are funneling the economy's rewards to a smaller group of people -- and corporations.

So, basically, today's IPO market isn't much like that of 1990s at all. It just isn't clear whether that's a good thing or a bad thing.

  1. Ritter's numbers, in case you're wondering why they're different from other numbers you've seen, exclude banks and thrifts, companies that were already traded in other countries, American depositary receipts, real-estate investment trusts, special-purpose acquisition companies and oil and gas partnerships or unit trusts.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Justin Fox at justinfox@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net