Zynga Set To Debut Amid Burst Of Pricings

With Zynga set to headline America's busiest week for IPOs in four years and Facebook reportedly prepping a 2012 public offering, all seems well in the new issue market.

Zynga, maker of FarmVille and other Facebook-based games, could be the largest U.S. Internet IPO since Google (NASDAQ:GOOG - News). The market has also seen high-profile social networking debuts such as LinkedIn (NYSE:LNKD - News) and Groupon (NASDAQ:GRPN - News).

But costly government regulation and legislation over the past decade have significantly slowed the flow of new public firms.

The burden has deterred entrepreneurs and their venture capi tal backers. That in turn hurts job creation and economic growth.

"Emerging-growth companies have been squeezed out of the IPO market," said Kate Mitchell, managing director of Scale Venture Partners and chairwoman of the IPO Task Force when it issued its "Rebuilding the IPO On-Ramp" report Oct. 20.

From spurring the rise of online brokerages and low-cost trading to cracking down on accounting fraud and financial meltdowns, Washington's "well-intentioned" changes have had "unintended consequences," says David Weild, former vice chairman of Nasdaq and now a senior adviser at accounting firm Grant Thornton.

Among other things, the rules restrict more widespread dissemination of information to investors. They also force CEOs to spend more time and money on compliance rather than focusing on building their business.

IPOs, Overall Listings Down

Since the collapse of the dot-com gold rush in 2000, the market for IPOs has not recovered. The U.S. has averaged 126 IPOs per year since 2001 vs. 530 per year from 1991 to 2000, said Weild. So far this year, 116 companies have listed in the U.S. Twelve are set to debut this week.

"We've seen a big decline in companies listed on U.S. public markets," to about 5,000 from 8,500 Weild said. "Companies that could employ lots of people are being plucked out.

Markets may be missing out on nurturing potential all-star companies. Weild cites Intel (NASDAQ:INTC - News), which came public in 1971. Just three years old, the chipmaker was unprofitable and came public with a $44 million market valuation in today's dollars. A company like that would never make it to the IPO stage today, he said.

Many small companies decide it's not worth going public. Without the potential home run of an IPO, venture capital firms are less likely to provide early funding, as they did for Apple (NASDAQ:AAPL - News), Intel, Microsoft (NASDAQ:MSFT - News), Cisco (NASDAQ:CSCO - News) and FedEx (NYSE:FDX - News).

"About 90% of job growth by venture-capital-backed companies occurs after the IPO," said Pascal Levensohn, managing partner of Levensohn Venture Partners. "We are not addressing the liquidity issue for small companies. It's the sum total of the unanticipated consequences from regulation that have been added over time.

The legislative and regulatory changes in the past 15 years aimed to level the playing field for investors by increasing market competition, altering how companies disclose information and lowering trading costs.

Weild traces the regulatory impact on IPOs to seemingly unrelated changes at the height of the new issue boom in the late 1990s. Rules that introduced "alternate trading systems" led to electronic communication networks (ECNs) that let consumers execute trades directly with major brokerages. That was followed by "decimalization" in 2001 intended to lower trading costs.

Sophisticated and tech-savvy investors welcomed the changes. But it opened the door to high-frequency, high-volatility trading by people who make rapid buy and sell orders to make a profit from small price changes that disrupted a delicate balance.

Among other things, many broker-dealers found that researching and promoting newly public companies was no longer profitable. They effectively abandoned that line of business, to the detriment of smaller public companies. It also forced out many smaller investment banks that actively issued small-cap IPOs.

In 1986, Microsoft did a $58 million IPO that included 116 mostly small underwriters. Most are now out of business. LinkedIn's 2011 IPO had only 5 underwriters even though it was six times bigger.

"Literally overnight, small IPOs of $50 million and under went from dominating the IPO market at about 80% to only 20%, and we've never recovered," said Weild. "These are companies the average person has never heard of." The promotion of small-cap companies was vital to the emergence of Silicon Valley.

Cracking Down

But the tinkering was far from over. Major corporate accounting scandals at firms like WorldCom, Enron and Tyco (NYSE:TYC - News) led to the Sarbanes-Oxley Act of 2002. The aim was to restore public confidence by strengthening accounting controls, among other things. The downside was the compliance cost and time, hitting smaller firms the hardest.

The sweeping 2010 Dodd-Frank Act further tightened financial reporting laws.

Not everyone is disheartened.

The near-term IPO outlook shows signs of improving, says Peter Astiz, who provides general counsel services for high-tech companies as co-head of the technology sector at law firm DLA Piper.

The number of companies on file to go public is currently at near-record levels.

Europe's debt crisis has put stock markets on a roller-coaster ride. Resolving that problem would likely allay fears of a global recession and spark global stock markets.

More generally, while blaming regulations is "politically convenient," Astiz says the biggest factor for IPOs is "overall macro conditions.

"There is no question that regulations created impediments, but in the big scheme of things, boardrooms are not deciding whether to go public because of Sarbanes-Oxley or something like it," Astiz said. "The real question is, what is the premium value they can get by going public vs. a private sale."