The New Rules of the IPO
Can a new stock exchange backed by the Bay Area?s most powerful players take on the NYSE and Nasdaq?
Ries has lined up powerful backers ? friends, former coworkers, clients, and investors that he has collected through his varied career. The LTSE has raised $70 million from a who?s who of Silicon Valley VCs: Andreessen Horowitz; Collaborative Fund; Peter Thiel?s Founders Fund; Initialized, the firm run by Reddit cofounder Alexis Ohanian; and Obvious Ventures, an early-stage VC firm co-founded by Ev Williams (founder and CEO of Medium, which Obvious is also an investor in). LinkedIn co-founder Reid Hoffman, now a partner at venture firm Greylock Partners, is also in, along with AOL founder Steve Case. But Ries himself is the biggest shareholder in the for-profit exchange; before the LTSE?s most recent funding round, he held a 29% stake.
If companies and investors buy into Ries?s big idea, that the public markets are broken and a fundamental change is needed, there is a giddying upside. Not just for Ries and his investors ? running a securities exchange can be a very lucrative business ? but for every striving startup founder and Main Street investor. But, as we?ve seen before with other new stock markets, there?s also a very good chance the whole thing could fizzle.
Ries and his fellow travelers argue that this sort of unchecked short-termism in public markets is especially disruptive to companies with long-term innovation cycles ? the very companies we?ve come to look to for exponential returns. ?If you?re a tech company, the product cycle lasts four to seven years, if you?re lucky,? says Margit Wennmachers, an operating partner at Andreessen Horowitz, a major LTSE shareholder. ?You get continually disrupted unless you can make significant investment in long-term R&D.?
For all these reasons ? plus the cost and general pain of hiring an investment bank to take you public and grinding through the ritual ?roadshow? ? companies have been staying away from IPOs in droves, remaining private as long as possible. The median time to IPO is now about seven years, versus roughly three years in 2010. The number of companies filing IPOs has plunged from 500 or 600 a year through the 1990s to 100 or 200 for most of the past decade.
?It looks like a falling knife on a chart,? says James Joaquin, co-founder and managing director at Obvious Ventures, an early LTSE backer. ?The companies that have IPO?d recently have used duct tape and baling wire solutions, like dual- and triple-class shares, in an effort to insulate themselves from volatility.? (Such arrangements reward some shareholders, usually founders and early investors, with more say in corporate governance.) This isn?t just an issue for company founders, though ? it?s a concern for the 55% of Americans who invest in publicly traded companies to fund college, retirement, and other big dreams.
Fundamentally, exchanges exist to connect companies with investors who believe in those companies ? and everyone shares in the gains. The LTSE, Ries says, wants to help companies find investors whose timelines and broader priorities align with their own, letting them get off the quarterly earnings treadmill. It will do this, Ries says, by requiring all LTSE-listed companies to commit to a common set of principles. So, in addition to SEC rules that all public companies must follow ? obligations to publish quarterly reports, have independent directors, and the like ? LTSE-listed companies will also tell investors exactly how they will do things like promoting diversity and sustainability and ? here?s the crux of it ? focusing on ?long-term value creation.? Companies that go public on the LTSE will commit to measuring success in years and decades, aligning executive and board compensation with long-term performance, giving boards explicit oversight of long-term strategy, and ?engag[ing] with long-term shareholders.?
For each principle, companies are asked to adopt and publish specific operational policies responsive to it. The LTSE checks that the policies are, in fact, aligned with the principles. ?If you come in and say that your sustainability plan is to burn a lot of coal,? Ries says, ?we can say, No.? What the LTSE won?t do is to ?independently verify that a company is in fact purchasing renewable credits for every ton of carbon they emit, or checking the solar panels on a data center in Des Moines,? says Michelle Greene, the LTSE?s president, a former Treasury Department official under Presidents Clinton and Obama who went on to run the NYSE?s global corporate responsibility program. ?If we become aware that a company isn?t following its stated policy,? she says, ?we would address it with the company.? Companies found to be significantly out of compliance with LTSE principles can be delisted. That leaves a big role for shareholders in keeping companies honest.
The LTSE won?t do anything to stop investors from selling shares when they want to. ?We still believe in full liquidity,? Ries says. But only investors who ?buy in? get to benefit from companies? long-term ?loyalty programs.? Investors must agree to disclose the beneficial shareholder of a stock in order to enjoy super-voting privileges and other programs. (One of the LTSE?s unique value propositions is automating the ability of companies to track their long-term investors, a technically challenging problem.) That?s a level of exposure not normally required of public-company shareholders, and it?s key to Ries?s vision.
?I spent a lot of time researching a way to implement LTSE without having to become a freaking national securities exchange,? he says. ?Could we be just a Good Housekeeping Seal of Approval? Could we just be a pledge? Could we just be a club or a coalition or an index? But none of these had the two-sided teeth that a multi-sided market needs. We have to be able to regulate the behavior of corporations and investors at the same time, and they each have to be able to make binding pledges to take this seriously.?
Then again, the LTSE might not disrupt much at all. Indeed, there are indications that the American appetite for new stock exchanges is sated. The IEX, launched with much fanfare in 2016, offered bargain listing fees for companies but managed to sign up just one customer, Interactive Brokers, for its listing service. When that company jumped ship to Nasdaq last fall, IEX announced it would abandon its listing business and focus only on trading.
?I?m in favor of experimentation, innovation, and more competition ? so I applaud those trying to make the LTSE work,? says Harvard?s Fried. ?However, I have trouble seeing why the LTSE is necessary. R&D spending by public firms is at a record high in absolute terms and relative to revenues. Long-term investors have done and continue to do very well.? Plus, any governance arrangement required or permitted by the LTSE to promote long-termism could be voluntarily adopted by a firm going public on another exchange. ?The current stock exchanges ? along with U.S. securities and state corporate law ? already give founders substantial freedom to tailor their firm?s governance arrangements,? says Fried. ?The only limit to such tailoring is what investors will accept at the IPO, and this restriction will not be loosened by the existence of the LTSE.? The most likely scenario, he says, is that the LTSE will become a place where ?Silicon Valley founders and VCs might want to list firms for marketing purposes, to benefit friends involved with the exchange, or for the relative convenience of dealing with a California-based institution.?
Like any good Bay Area founder, Ries ? who lives in San Francisco?s Cole Valley neighborhood with his wife, Tara Mohr, an author and performance coach, and their two young kids ? wants to make the world a better place. He and his major investors tout the exchange as a refuge for everyday investors, a level playing field where they might realize the kinds of gains that right now only well-connected private equity investors can typically access.
Ries points to the pension fund guys attending the investor coalition meetings. ?They?re at no tech conferences,? he says. ?They?re at zero roadshows. They can?t get into the good funds. You couldn?t design a public-policy regime that?s stacked more against them if you tried. But like, Texas Teachers, who would you rather be making money for??
More significantly, through super-voting shares, these sober, responsible entities will get more influence over public-company ethics, he says. ?Short term-ism has huge consequences for environmental sustainability, for inequality, for diversity for people,? Ries says. ?Are we going to find a way to share the wealth with the public or not? As a technology industry, are we going to find a way, once again, to earn the public?s trust, or not? The world has mega problems and they?re obviously going to require entrepreneurship and innovation to be solved. How we strengthen and support those folks in our society is an urgent civic question.?
That said, Ries and his investors stand to profit handsomely if the LTSE takes off. ?This is a for-profit company, and we expect to make venture-scale returns because exchanges are very powerful financial organizations,? Ries says.
Exchanges make money through trading fees, listing fees, and fees for data and tools used by traders. In 2018, Nasdaq?s net revenues were over $2.5 billion; NYSE?s were nearly $5 billion. Initial listing costs on the NYSE or Nasdaq start around $50,000 and can run into hundreds of thousands, depending on company size. Companies also pay an annual fee to maintain their listing. In January, the LTSE published its proposed listing fees, which start at $150,000 for initial listing with a minimum $150,000 annual fee. (The lower listing fees published by the other exchanges don?t include an array of opaque ?add-ons? ? application fees, marketing fees, fees for issuing new shares, etc. ? that make the total cost comparable to the LTSE?s flat rate, says Goldstein.)
Unlike other exchanges, which charge a range of transaction fees on each trade (hidden to the average retail investor, who typically pays a rounded-up fee to a third-party broker), the LTSE won?t charge any. Exchange ?members? ? brokers and brokerage firms ? just pay a $10,000 annual membership fee to conduct business on the exchange. Ries hopes this helps discourage pushy brokers from encouraging trades just to generate transaction fees. ?The vast majority of retail investors are trading for their retirement,? Ries says. ?We think we are truly aligned with the interests of these investors, not brokers trying to run up commissions.?
There?s none of that fun business of ringing the opening bell in the cloud. And there?s a very real risk that an IPO on the LTSE could be the proverbial tree falling in a forest.
Many of the LTSE?s venture backers could also benefit from a new venue for their portfolio companies to go public. ?Eventually, we want our money back,? says Wennmachers, from Andreessen Horowitz. ?Having a third public option is compelling.?
Ries makes no apologies for doing capitalism. ?We as a society made the decision to convert exchanges from nonprofits to for-profits,? he says. ?I don?t know if that was a great choice, but we did.? LTSE?s backers share wide-ranging motives, he says: ?No matter who you are, I guarantee you will have strong ideological disagreements with at least some of our investors. [But] for all of our disagreements, we share common concerns about the future direction of our country and of capital markets.? And they?re committed long-term ? everyone?s shares vest over 10 years.
The LTSE says that about 20 companies have signed letters of intent to list on the exchange, but confidentiality agreements prohibit naming them. Two of the best-known businesses rumored to be considering listing on the LTSE are Airbnb and Stripe, but both declined to comment for this story. One founder who agreed to speak on record is Greg Piefer, the CEO and founder of Shine, a Wisconsin company working to produce nuclear isotopes for the medical industry. ?A lot of what Eric is trying to do here really resonates with how I?d like our company to be,? he tells me, on a break from the investor coalition meeting in San Francisco. ?We have a very long-term value proposition. I think we can really accelerate what we?re trying to do with increased access to capital, and I think the public markets are a great place to do that.?
But how many Piefers are out there? For all its promised benefits, the LTSE asks a lot from already frazzled founders. There?s none of that fun business of ringing the opening bell in the cloud. And there?s a very real risk that an IPO on the LTSE could be the proverbial tree falling in a forest. That?s why Ries has been playing up the dual listing option ? LTSE-listed companies can also list on the NYSE or Nasdaq, benefiting from the broader exposure of an established exchange while also committing to the values of the LTSE.
Ries and his surrogates are carefully managing expectations. ?It could be a while until we have a critical mass of listings,? he says. ?We hope that by being in the room in all of these decision-making processes and influencing these companies, whether they list or not, we can start to see more companies who are taking a 21st-century approach. In the next year, you?ll start to see the impact of our work start to become evident.? Whether the LTSE becomes a legitimate rival to the big two exchanges, or as critics suggest, a sandbox for West Coast oligarchs, is ultimately up to the market to decide. It?s capitalism, after all.
This story is part of The New Rules of the IPO, a multi-part special report.