Our innovation economy won’t grow until we fix the broken IPO market

It’s been 12 years since the internet bubble burst, and in the ensuing fallout, it has become apparent that the IPO market has been fundamentally damaged. Thanks to a lack of national confidence and lingering fears and confusion about the potential risks of IPOs, far too many good companies – ones that could supply much needed jobs to the U.S. economy – are unnecessarily paying the price. While addressing the fouled IPO market certainly  isn’t a cure-all for our ailing economy, there’s no doubt that some of America’s missing growth and lost jobs over the past decade are certainly to be found locked away in this hidden treasure chest.

Breaking the IPO market

We can look back now and see that permanent structural changes that were prompted as a result of the dot-bomb crisis– many initially subtle and gradual – shifted our markets so that we frogs didn’t realize that our cold-water world was slowly coming to a boil. And we got cooked.

In fact, a host of factors have contributed to the process. Electronic trading, decimalization, consolidation of the ‘Four Horsemen’ boutique banks into the bulge bracket banks, and the dominance of hedge funds — all these factors helped transform our investment focused public markets into a high-velocity, high-volume trading world. And that has choked the ability of young companies to get the long-term growth support they need to create more jobs for the rest of us.

New regulations to control the underlying corrupt financial practices that helped create and burst the bubble also hindered the growth of legitimate companies with IPO potential. Sarbanes Oxley and analyst regulations added costs while removing critical support. The result has been that the number of years to IPO has been shifted from an average of under five years, to over 10 today. These structural changes in the financial markets have stunted capital formation and in essence broken the IPO process.

Accepting and promoting our new economy

President Obama stated in his recent State of the Union Address that America’s future will come from rebuilding a strong middle class. However, the belief that the solution to moving forward is to resort to the old manufacturing economy is wrong. If we look back over the past 20 years to where the greatest number of jobs have come from, the answer is new-economy companies like Apple, Google, Amazon and Starbucks, which each employ about 300,000 people.

We are now in an “innovation economy” growth phase cycle, and because it is specifically dependent on IPOs – with 92 percent of job growth for companies occurring post-IPO– one can easily connect the lack of growth and jobs over the past decade right back to when IPOs became blocked.

To deliver middle class jobs in the U.S., Mr. Obama needs to focus on creating more tech jobs – which, according to Moretti’s multiplier of five, spawn three middle-class jobs and two professional jobs each.

Preparing CEOs for today’s market realities

What is most wrong with the system is that it is skewed to incentivize short-term focus. Today’s high frequency trading benefits from volatility and in effect creates pump-and-dump scenarios. For IPOs, that translates to often wild price fluctuations, with from 300 to 500 percent of IPO allocations usually trading within the first 48 hours of a company’s offering.

The solution is for company CEOs to take back the reins and factor in aftermarket trading. Managing your shareholder base composition is a basic investor relations function that companies need to begin developing years prior to IPO, including inviting key shareholders into late-stage private rounds. A good rule of thumb is to aim for 60 to 70percent long-term holding base for stability, and 30 to 40 percent short-term holders for liquidity. This yin-yang balance will support a perception (stock price) that matches reality (fundamental performance).

Without a core of growing companies (that are appropriately valued), the economy will simply keep generating more uncertainty and distrust, further limiting good, young companies’ ability to hire and grow.

Mona DeFrawi is founder and CEO of Equidity, a firm that matches investors with private companies. Follow her on Twitter @MonaDeFrawi.

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