IPOs and the Economy

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Initial public offerings (IPOs) have many additional benefits other than just raising
capital for the company issuing shares to the public. The broader economic impacts of
an IPO significantly surpass the benefits specific to any single company. Although the
IPO process can be demanding, its positive contributions to the economy further
support the case for pursuing an IPO.

This article explores how IPOs contribute to job creation, enhance market efficiency,
and drive economic growth. It also provides insights into the future outlook of the IPO
market.

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What is an IPO?

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While IPOs are common in the business world, understanding the topic can be difficult.
Simply stated, an IPO is when a company offers shares of capital stock to the general
public for the first time. A company typically starts by filing a registration form with the
SEC called an S-1. To learn more about how an S-1 form is structured, please read this
article from IPO Hub.

Deciding to issue an IPO takes initial planning and preparing, as well as collaboration
with other functions such as underwriters (usually an investment bank), lawyers,
accountants, and the corporate finance team. Furthermore, timing is of the utmost
importance when considering an IPO. Market conditions play a huge role in the timing
and success of the IPO. For example, if the current market is not receptive to an IPO,
then an IPO can do more harm than good for a company. IPO readiness is a huge
factor in the IPO decision process and should only be considered if the market
conditions are conducive to the offering. To learn more about preparing and evaluating
IPO readiness please read this article. ‍

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IPOs and Job Creation

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An IPO’s benefits spread much further than for just the company that goes public and
accompanying investors. One spillover benefit of an IPO is job creation and therefore a
growing economy. As explained in academic research performed at Rice University, “Zip
codes close to a company’s headquarters see certain home prices and consumer
spending rise, while more businesses and jobs are created.” The prospect of going
public is exciting and beneficial, and all people and businesses in the surrounding area
experience the spillover effects from the IPO.

The same academic research from Rice University quantifies the benefits of an IPO in
relation to job creation. Mainly, “…When an IPO occurs, each $10 million in proceeds
leads to an extra 0.7 new businesses in the surrounding area and 41 new local jobs.”

The investment and capital creation resulting from the IPO benefits those living in the
area through improved business. New businesses lead to continual economic growth
and the potential for more IPOs in the future. The research from Rice University
explains this interesting phenomenon and why it could occur. One observation
highlights that the “positive effect comes from the change in listing status, not from
capital raising.” An IPO does not create a new company but rather changes the listing
status of a company that already exists. The positive benefit to economies come from
this change in listing status and not the amount of capital raised in the IPO. To further
test this hypothesis, the researcher also looked at the impact that seasoned equity
offerings (SEO) have on local economies. SEOs do not have a change in listing status,
only capital raising. Sure enough, the researchers found that SEOs did not generate the
same positive impact on economies that IPOs do.

As mentioned above, home prices are also impacted by IPOs. The research explains
that home prices receive a boost after the lockup period ends and shareholders can
then sell their stock. This supports the hypothesis that changes in investor liquidity
cause the spillover effect observed from IPOs. To assess this phenomenon, researchers
compared many figures such as the change in home price, new mortgages, and credit
card spending. According to the data, “…each $10 million in proceeds leads to an extra
0.7 new businesses in the surrounding area and 41 new local job.” Also, expensive
home prices within the zip code where the IPO takes place do not experience growth
compared to expensive home prices in other zip codes within two miles of headquarters
of the IPO.

Rice University quantifies this amount as “by $3900 for the average
expensive home valued at $590,000.” This is not to say that home prices in the zip code
of the IPO did not increase, but they do not increase at the same levels as homes in zip
codes two to five miles away from headquarters did. Also, the research conveys one downside.

Unfortunately, IPO activity has a negative
impact on low-income individuals living in the area of the IPO. Some residents may
have to move to lower-income zip codes to stay afloat.

Facebook’s IPO is a great example of the tendencies described by the research as
highlighted in the article titled, “Facebook IPO: How Stock Offerings Help the Economy.”
Professor Steven Kaplan explains in the article that the prize of potentially cashing out
provides incentives for entrepreneurs to found businesses, proving that a healthy IPO
market is almost directly linked to overall economic innovation.

In the wake of the 2020 Covid-19 pandemic, Tom Quaadman, who was the Senior Vice
President of Economic Policy in the US Chamber of Commerce, explains that the IPO
market is the key to regaining jobs lost during the pandemic. The IPO market creates
prosperity by promoting growth and investment opportunities. Innovative companies that
decide to undergo an IPO to raise additional capital fuels jobs and growth.

Also, IPOs let average investors purchase stakes in companies within the equity market. When the
IPO market is healthy, more jobs are created and the future growth ensures the
economy continues to progress.

Jay Ritter, a professor from the University of Florida, studies IPO trends and found that
when observing IPOs from 1986 through 2000, the IPO company added 822 employees
on average, resulting in a 60% growth in employment over a ten-year period. The main
observation from Facebook’s IPO is that big IPOs, such as Facebook, beat the market
by 2.6%, providing evidence that IPOs create value for investors and the entire
economy.

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How do IPOs Influence Economic Growth

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An IPO stimulates the economy through capital formation and wealth generation. A new
stock issuance provides access to capital markets leading to investment in new
operations and projects, improving innovation. As explained in the article, “How a
Strong IPO Market Supports Economic Growth,” a thriving market for IPOs is the most
direct and tangible evidence of an economy where new businesses have confidence in
their future prospects. When the economy is strong, more IPOs occur contributing to
continual stimulation of the economy. When the average person is struggling to make
ends meet, less money is poured into the economy through investment, therefore
stifling growth. A strong and healthy economy provides an opportunity for successful
IPOs that in turn continue to stimulate the economy going forward.

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Future Outlook for IPOs

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To best understand the future of IPOs, it is beneficial to look at the past couple of years
of IPO history. Post Covid-19 pandemic, IPOs soared, mainly through the popularity of a
process known as special purpose acquisition company (SPAC). PwC’s Global IPO
Watch highlights just how significant the 2021 IPO market was by describing that
“Proceeds were up to $346bn, more than the previous three years combined as
companies looked to take advantage of ripe IPO conditions – high valuations, low
interest rates and strong investor appetite for equity.” To learn more about what a SPAC
is and how to successfully complete a SPAC, please visit this article.
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The stark contrast between market conditions in 2021 and 2024 highlights how much
slower IPO activity has been in the first half of 2024 compared to the rapid pace seen in
2021. One key contributor to the slowed IPO market is high interest rates. As of
September 2024, the Fed finally announced an interest rate cut after months of
anticipation. Although a small cut, this should spark IPO activity, and the anticipation of
the coming years will fuel the current market.

The future outlook for IPOs looks positive and will only continue to get stronger. The EY
Global IPO Trends Q3 2024 document expresses positive sentiment saying, “So far this
year, mega IPOs showed a clear trend toward recovery compared to the previous year,
along with a consistent resurgence of PE-backed exits via IPOs.” Although IPOs are not
back to pre-covid levels, they are positively growing. Many factors are considered when
predicting the future of IPOs for the year 2025.

These factors include interest rates, access to capital, and inflation. EY continues by predicting that, “Lower interest rates
and the easing of inflationary pressures could offer some relief to companies looking to
go public by reducing the cost of capital and encouraging investments in new ventures.”
On September 18, 2024, the Fed made a long-awaited 50 basis point cut to the federal
funds rate. Although people were expecting a larger cut, this action signals to investors
that steps are being taken to improve the economy, fostering hope for increased IPO
activity in the future. Lower interest rates lead to higher valuations, showcasing IPOs as
a more attractive investment. Additionally, a rate cut signals economically favorable
conditions, increasing optimism and trust in IPOs.

In November 2024, the United States of America elected President Trump to be the 47 th
president. The Trump administration is expected to implement policies that reflect a pro-
business stance, further impacting the future outlook of the IPO market. One key signal
is that in the time since President Trump was elected, investment banking stocks have
risen by a large percentage. Specifically, as of November 17, 2024, the S&P 500 is up
more than 3.5%, and the Dow Jones and NASDAQ have also risen by 4%.

In a Yahoo finance article, Jay Ritter comments on this trend hypothesizing that an
increase in IPO activity will have more to do with the stock market rally as opposed to
Trump’s potential policies. Given that the stock market performed so well as a result of
the election, it is likely that the IPO market will pick up in 2025 and continue to improve
as the year continues on.

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Conclusion

The benefits of an IPO extend beyond simply raising capital for the issuing company.
The broader economic impacts often outweigh the specific advantages to individual
companies. Despite the challenging and demanding nature of the IPO process, its
positive effects on the economy highlight why pursuing an IPO can be a valuable
decision.