Markets In Action

Is Brightening 2015 IPO Outlook A Good Sign for the Economy?

When FitBit, maker of a popular personal fitness tracker tool, began trading shares of the company on the New York Stock Exchange on June 18, it wasn’t just good news for the company’s investors-it may have been a positive reflection on the economy as a whole.

After several years of sluggish recovery in the U.S. economy, the number of firms pursuing initial public offerings (IPOs) in 2014 and 2015 could reflect a broader increase in optimism among both investors and consumers.

IPOs are one of the avenues through which smaller companies connect through the capital markets to the larger pools of investment they need to grow.

Here’s how it generally works: a company decides to raise capital by selling its stock to the public, which means individual investors as well as institutional investors, like mutual funds and retirement funds.

This process, known as “going public,” allows the business owners to raise equity financing. The IPO company works with an underwriter, a financial firm such as a bank or securities broker dealer, to help the company with the structure and timing of the offering.

The IPO process also helps to set the price of the company’s shares once it begins trading on public markets, such as stock exchanges, where individual investors can begin purchasing the shares.

Plenty of the companies you do business with and products you use everyday-McDonalds, Google, Facebook, Wal-Mart, Twitter, Under Armour, Ford, the list goes on-at some point chose to raise equity financing through an IPO as a launching pad to secure the capital investment they needed to grow and prosper.

2015 Public Offerings Gaining Steam

After a banner year for U.S. IPOs last year, the first part of 2015 saw a slow start, with 34 IPOs priced in the first quarter, according to a recent report by Michelle Gasaway and Michael J. Schwartz of Skadden Arps Slate Meagher & Flom LLP.

According to Thomson Reuters, with 65 IPOs priced in the second quarter priced at a value of $13.4 billion, the U.S. market for IPOs may be gaining steam.

That builds upon the record year for IPOs in 2014, when 300 U.S. IPOs raised over $94 billion in new capital-the biggest year for new offerings since 2000. Gasaway and Schwartz note that the heavy IPO activity last year may have “cleared the IPO pipeline,” so to speak, for the early part of 2015.

“I think the waters appear to be warming in the equity market, and investors are hungry for fresh growth ideas,” said Alan Gayle, director of asset allocation at RidgeWorth Investments, tells the Wall Street Journal. “When the market starts to show some life, you find there’s greater appetite for IPOs.”

The Upside of Going Public

So why do IPOs matter? First, a portion of the immediate benefits of a successful IPO go to company founders, early investors and venture capital investors who saw the company through its difficult early stages.  That’s their “payoff” for the risk they took on in supporting a company during its early years.

But even if you’re not an investor, there are broader economic impacts from a healthy IPO market for companies going public. When a company launches an IPO to gain access to a broader pool of capital, it points toward growing confidence in the trajectory of the economy.

To begin with, newly public companies can be engines for new job creation. As University of Florida Professor Jay Ritter, an expert on IPOs, testified to Congress in 2012, a wide-ranging study of more than 2,000 firms that underwent IPOs between 1986 and 2000 found that they added an average of 822 employees after going public.

IPOs also serve as an incentive for innovation, since going public helps to reward the risk-taking of entrepreneurs and early investors. And greater innovation is a plus for the economy and for consumers as a whole-just think of how the companies that manufacture the computers and smartphones that are part of the daily fabric of our lives used IPOs to secure the capital they needed to grow.

Not all companies choose to go the IPO route. Some founders and managers prefer to keep their company private and pursue a more gradual expansion; others may follow a merger and acquisition strategy to partner up with other companies.

And of course, not every company that goes public is guaranteed to prosper in the long term – even companies with high-flying IPOs can face challenges down the road. That’s one reason it’s a good idea for investors to consult with an investment professional to determine if investing in companies that have recently or plan on going public is right for their portfolio.

But one reason IPOs are important is because they’re a highly visible illustration of how capital markets can allocate needed financing to companies looking to grow. And while it’s not the only economic indicator that matters, a growing number of IPOs might be pointing toward broader future growth-a development we would all welcome.