The market for initial public offerings (IPOs) in the United States has exceeded expectations in the first half of 2024. According to Renaissance Capital, 69 IPOs were priced by June 30, 2024, marking a 32.7% increase compared to the previous year. Total proceeds reached $16.7 billion, a remarkable 87.3% increase from 2023. Filing activity has also seen an uptick of 21.6%, and after-market performance has risen by over 7.4%, although this lags behind the broader market’s 15.3% increase.

A Historical Context

To understand these developments, it’s crucial to recognize that 2023 and 2022 were exceptionally challenging years for IPO activity, marking the darkest period for IPOs in over two decades. However, the decline in the U.S. IPO market is not a recent phenomenon. Over the past 25 years, the market has been in a state of gradual decline with only brief recoveries. On average, the past decade has seen just 135 IPOs per year, a third of the activity witnessed in the 1990s. Additionally, the number of publicly listed U.S. companies has halved since 1996 due to the increasing costs of maintaining a public listing and the broader economic environment.

Long-Term Structural Challenges

Several long-term structural impediments have contributed to this decline:

• Decimalization of Trading: The shift to penny-based commissions reduced brokers’ margins, leading them to focus on larger public companies at the expense of smaller ones.
• Global Analyst Research Settlements: These 2003 agreements between Wall Street banks and regulators made research coverage for smaller public companies prohibitively expensive.
• Brokerage Concentration: The consolidation of brokerage activities in large banking corporations has marginalized smaller public companies.
• Regulatory Burdens: Laws like the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Act of 2010 have significantly increased compliance costs, making the IPO process more expensive and burdensome, particularly for smaller companies.
• Rise of Private Capital: The growth of private equity and other private capital sources has reduced the incentive for companies to go public.
• Shift to Passive Investing: The move from active to passive investment strategies has favored large-cap companies, further marginalizing smaller firms.

These factors have led to a U.S. equity market dominated by the largest companies, often referred to as the “seven sisters” (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla). Without structural reforms, these trends are likely to continue, posing challenges for the broader market and the U.S. economy’s capacity for innovation and job creation.

Recent Impacts

Recent events have also imposed new challenges for the IPO market to recover:

• Rising Cost of Capital: The Federal Reserve’s rapid interest rate increases in 2022-2023.
• Market Volatility: Significant corrections in equity market prices and poor IPO after-market performance.
• Private Market Dynamics: Overpriced private financings have made IPOs less attractive.
• SPAC Collapse: The rise and spectacular fall of special purpose acquisition companies (SPACs) have added to market instability.
• Global Disruptions: Supply chain issues, geopolitical tensions, and political uncertainties.
• Tax Uncertainty: Looming expiration of corporate tax reductions and potential changes in federal and state tax rates.

The Outlook for 2024 and Beyond

Despite these challenges, the outlook for the IPO market in the second half of 2024 and early 2025 appears positive. Indicators of increased risk appetite, such as the surge in Bitcoin prices, suggest a potential rebound. Expectations of Federal Reserve interest rate cuts, stronger after-market performance of recent IPOs, improving earnings reports, and a substantial backlog of companies preparing to go public all point to a brighter future.

Promising Sectors

Two sectors are particularly promising for IPOs:

1. Healthcare and Biotech: Innovations in CRISPR and artificial intelligence, combined with the essential nature of healthcare products, make this sector highly attractive.
2. Green Energy: Increasing focus on sustainability and industrial policies favoring renewable energy are driving growth in this sector.

Within the technology sphere, enterprise software and fintech companies are likely to lead the IPO charge, given their steady demand and the need for venture capital and private equity investors to secure returns.

Investor Sentiment

Currently, public market investors are selective, prioritizing established profitability and sustainable growth. Historical data shows that investor demand for IPOs correlates with the returns they offer. With IPOs yielding a 4.84% return in 2024 compared to the S&P 500’s 15.61%, investors are understandably cautious. Consequently, the IPO market needs to demonstrate more robust returns to attract significant investor interest.

Conclusion

While the IPO market faces substantial long-term and recent challenges, the first half of 2024 has shown some signs of improvement, leading to hesitant optimism for the second half. Strategic focus on promising sectors like healthcare, biotech, and green energy, coupled with favorable market conditions, could herald a resurgence in IPO activity. However, achieving sustained growth will require addressing the structural impediments that have long plagued the U.S. IPO market.