Death of the IPO Dream
Going public once represented wealth, recognition, and fame. What is the point of being an entrepreneur when an IPO is a diminishing option?
By Ian Mount

(FORTUNE Small Business) – Great entrepreneur takes world by storm is the headline that David DePaolo imagined would accompany his handsome photo on the cover of Fortune magazine. Such dreams were in part what drove him and two others to found WorkCompCentral in August 1999. The founders of the company, which is based in Camarillo, Calif., and sells workers' compensation data over the Internet, were ardent believers in a bold path that had become part of most entrepreneurs' guiding mythology: "The intention definitely was to build it quickly, acquire venture capital, get real big real fast, do an IPO--and everybody walks away with fat and happy wallets," says CEO DePaolo, 45. Today, although his company is profitable and growing fast, going public is an entirely unpleasant thought. Over the past few years, "what has really gotten lost," he says, "is being able to grow a business in a manner that fulfills the American dream."

Time was when the very phrase "going public" conjured so much in the entrepreneurial imagination--an escape from bootstrapping anonymity into newsstand fame, the earning of the respected merit badge of capitalism's real winners, and, yes, a lot of cash.

Not anymore. A combination of Sarbanes-Oxley's steep compliance costs, Wall Street's neglect of small caps regardless of their performance, and heightened investor distrust has turned running a public company into a far less appealing proposition. The number of private firms selling out (instead of plying the IPO seas) is near an all-time high. And many public-company CEOs are yearning for privacy: The number of public companies fleeing the stock market hit record levels during the past two years.

Of course, selling shares to the public remains a viable and lucrative option for the highest-potential, fastest-growing firms (such as, say, Google). But the most profound changes are happening not in the marketplace but inside the minds of entrepreneurs. For many company builders, coming to terms with the fact that they might remain private (and--gulp--anonymous) forever has taken an emotional toll. Stephen Goldbart, a psychologist and co-founder of the Money, Meaning, and Choices Institute, a San Francisco counseling service for entrepreneurs, says that in 2000, 75% of those he worked with had dreams of an IPO; now that group's hopes have shifted to getting acquired. "Entrepreneurs have had to become more measured and contained about their objectives, and that's contrary to their core nature," Goldbart says. "They're wild thinkers, and the environment has told them to put it back into the box."

It's really no surprise that entrepreneurs such as DePaolo have wakened from their IPO dreams, given the kinds of stories they hear from their already public counterparts, such as the staffing-services firm Webhire, based in Lexington, Mass., which went public in 1996. In the wake of the Internet bust, the company's stock value dropped below $2 million--even though the firm was hoarding $5 million in cash and close to turning a profit. The Sarbanes-Oxley regulations would have added annual costs of $400,000 to the $16-million-a-year firm, according to Stephen Allison, then the CFO.

Webhire went "dark" in December 2002, effectively fleeing the public market by deregistering its stock. Between 2002 and 2003 the number of public companies going dark jumped to 198 from 67, according to Christian Leuz, a professor of accounting at the University of Pennsylvania's Wharton School. After the initial rush for the door, another 134 headed out in 2004.

Just as Sarbanes-Oxley costs were kicking in, small public companies such as Webhire were losing the attention of Wall Street analysts who had raised awareness of their stocks, because financially strapped brokerages were limiting their coverage to bigger companies. Research staffs have been cut by more than a third since 2000, says Ashwani Kaul, a senior market analyst at Reuters Estimates. Between January 2002 and February 2005 there was a 13.4% increase in the number of companies without brokerage coverage. And of the 682 companies that lost coverage, 668 were smaller businesses, with market capitalization under $1 billion. "If there's no research on you, nobody's going to touch your stock," says Kaul. The absence of analysts also makes money more expensive to borrow, according to Gary Gorton, a Wharton professor of banking who has studied how information availability affects the cost of capital. The typical small public firm, he says, now pays a 1.38 percentage point premium when it raises money, because of the uncertainty attached to orphaned companies.

Then again, being ignored might be better than the level of scrutiny that public CEOs now endure. The heightened personal liability that Sarbanes-Oxley places on public CEOs, coupled with corporate crusaders emboldened by the successes of New York attorney general Eliot Spitzer, has turned yesteryear's charismatic leader into today's incarcerated felon. In a 2004 survey of 150 Fortune 1,000 senior executives, almost all employed by public companies, 60% said they didn't want to become CEO, up from 27% in 2001, according to a study conducted by public relations giant Burson-Marsteller.

So what is replacing the once-momentous IPO? For one thing, private capital is plentiful and cheap. The amount of loans under $100 million made per quarter rose nearly 54% between 2001 and 2004. Then, as FSB reported in June 2004, there's the hot M&A market, which is being fueled by a surplus of buyers empowered by new online venues that make it easy to buy and sell a business nationally. Last year 6,027 private firms were acquired--a number bested only by the bubbled-up years of 1999 and 2000. And in a relatively new development, a small number of companies are registering to go public while simultaneously pursuing opportunities to be acquired (a strategy investors call "dual tracking"). Between 2001 and 2003 only five companies announced that they'd been sold while planning for an IPO. The same number did so in 2004 alone, and three already have in the first six weeks of 2005.

Clearly there is plenty of action--not to mention wealth--for those entrepreneurs who have turned away from the IPO goal. But with their prospects for recognition (and certainly fame) diminished, entrepreneurship itself seems less attractive to some. "What the markets and government have done in recent history has definitely stifled the thought that you can start a company and grow it into something that's recognized as a leader nationally and maybe even internationally. Would I try to do it today?" asks DePaolo, speaking not just of an IPO but of building a business. "Probably not."