Wall Street loves the 'boom' in big tech IPOs this year — but really, it's just a case of lowered expectations (MSFT, GOOG, GOOGL)

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The market for tech company initial public offerings is on the rebound this year, but the number of companies likely to debut on the public markets will still likely be far below historical norms.
The number of IPOs fell sharply with the dot-com bust and have never really recovered.
Politicians and pundits have blamed the relative dearth of IPOs on factors such as burdensome regulations and the flood of money in the private markets.
But Jay Ritter, a professor who has long studied the IPO market, says lack of tech offerings stems from a deeper change that started taking place in the economy even before the height of the dot-com boom.
That change, involving the profit prospects of small companies, has kept IPO numbers low, even despite regulatory reforms, Ritter said.

This year is seeing a resurgence in the market for initial public offerings from tech companies, but by historical standards, it still likely to end up looking disappointing.

Tech bankers are expecting some 50 to 60 tech IPOs this year. That's a significant uptick from the 38 or so that happened last year, but it's still significantly below the average over the last 35 years or so. And it's well off the pace of the dot-com era, when more than a hundred tech companies went public a year on a routine basis.

Jay Ritter, Professor of Finance at the University of Florida For much of the last two decades, people have been trying to figure out why we're no longer seeing anywhere near the number of IPOs we saw during the dot-com boom — and how to boost the market back to those levels. Politicians, policymakers, and market watchers have typically blamed onerous regulations. More recently, they've been pointing at the flood of cash in the private markets from investors such as SoftBank that's allowed companies to stay in business without having to turn to the public markets for funding.

But if you ask Jay Ritter, the pundits have missed the real causes for why tech IPOs haven't returned to their historical levels. The lack of IPOs can't really be blamed on SoftBank or regulations, said Ritter, a professor of finance at the University of Florida who has been studying the public offering market since the 1980s.

"The main reason" he said, "is that tech companies are selling out rather than going public."

The change in the IPO market predated the dot-com bust

Although pundits typically point to the dot-com bust as when the IPO market fundamentally changed, its transformation actually predates it. Even as the market for public offerings was hitting record levels in the 1990s, a smaller and smaller percentage of venture-capital backed tech companies were actually going public.

At the beginning of the 1990s, about 80% of VC-funded tech companies that didn't shut down went public, Ritter said. By the end of the decade, only 40% did, with the rest being acquired by other, typically larger companies, he said. Today, just 10% of venture-backed tech companies exit their startup phase with an IPO, he said.

The shift happened as larger and larger companies started to dominate particular sectors in the tech industry. In the 1980s and early 1990s, the market was fairly wide open, and entrepreneurs had a reasonable shot to build large successful firms in any number of different areas.

But the tech industry moves rapidly and tends to be dominated by network, and winner-take-all effects, Ritter said. Companies that enter and dominate a sector early tend to see increasing returns, while closing the door on competitors. That phenomenon has encompassed a growing number of areas in the tech industry, leaving fewer and fewer sectors available that have the room to allow a startup to become a huge corporation.

For a lot of tech companies, getting big fast is the value maximizing strategy, and organic growth takes too long

In the early 1980s, it was a reasonable bet to create a computer operating system company. Few saw that as a good prospect after Microsoft came to dominate the space by the end of that decade. Likewise, when Larry Page and Sergey Brin founded Google in 1998, the web search market was still wide open. That's no longer the case.

With the competitive landscape changed, founders of smaller scale startups have found it more profitable to build businesses that they could potentially sell to one of the existing tech giants rather than trying to develop them into standalone businesses, Ritter said. Many are working on technologies that might fill in product niches at larger companies, or that could help improve those companies' services.

"Small tech companies have not been going public," Ritter said. "For a lot of tech companies, getting big fast is the value maximizing strategy, and organic growth takes too long."

Ritter has been making this case for years now. In 2012, he testified before Congress as it was considering the legislation that became the Jumpstart Our Business Startups (JOBS) Act. The law was in large part an effort to boost the IPO market by reducing the regulatory burdens companies faced. Ritter argued that legislators were misdiagnosing the cause of the problem and that the legislation likely wouldn't boost the number of companies going public.

"With the benefit of six years of experience, I wouldn't change single word of what I said six years ago," he said.

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