How increasing income inequality is leading to a death of public markets
A couple of weeks ago at the Upfront Summit, legendary SV entrepreneur-investor and owner of the Dallas Mavs, Mark Cuban, talked about how companies are staying private for longer and how that is hurting the ecosystem. You can find his talk here: http://avc.com/2017/02/video-of-the-week-mark-cuban-at-upfront-summit/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+AVc+%28A+VC%29
Mark has been talking about this phenomenon for a long while now. What started as a rant against the SEC for killing the public markets with over regulation, has off late become an idea about the pride of taking a company public, and the importance of preserving the markets for greater good, like providing liquidity to mom and pop stores. This is something that further fuels his hypothesis that the present, what he believes to be, tech bubble is worse than the one in 2000.
Over the years the while public markets have contracted, the cumulative capital base in economies across the world has grown, and grown by leaps and bounds. To fill in the void, the private markets have consolidated their position. The rise of these private markets is more of a macroeconomic phenomenon than a simplistic idea that entrepreneurs don’t want to go public anymore because its too inconvenient.
For a long time, public markets were seen as this great melting pot where capital from all sources would interact to reach the most efficient conclusions. This included big institutional investors, to HNIs to moms-and-pops who would come here to generate a decent income stream for themselves. This was also a time of a more moderately distribution of income levels as compared to the present day.
The share of wealth held by the top 10% has grown from 62% of total wealth in 2002 to 74% in 2016. And its interesting to see that this rise correlates with the decline of pubic markets. A causation here is that as the rich became richer, the over-regulated public markets did not fully satisfy their desire of massive upsides. Even the smallest regulations like a cap on transaction frequency would move these people away from their most efficient barrier. This led them to create this big-boy-club wherein they created cordoned off markets for the rich to allow them to exploit the inefficiencies that the regulators did not want them to exploit. This is where Mark’s rant about how the SEC did not leave sufficient incentives for people to participate in the public markets starts making sense. These cordoned off markets are what we now call Private Equity, and most recently, Venture Capital.
What is interesting is that the rise of these tools, PE and VC, especially in India, correlate extremely positively with the increasing income and wealth divide. As the gap started widening, we saw PE first taking hold, and when it was not able to satiate the appetite of these investors, VC came out with an even higher-risk-higher-return proposition. Hence when we wonder why companies do not go public anymore, its because the cost-benefit-analysis does not make sense anymore as that source of capital which ,atleast from a company’s perspective, is cheaper, is also more robust than the more expensive kind (public markets). Hence ideas like entrepreneurs think its too inconvenient or that they don’t take pride in IPO-ing anymore, are mere products of the problem rather than being problems in themselves.
This bring me to my second point, the question of why we still aren’t in the bubble territory. While data regarding investments, deal flow and valuations (even after accounting for variables like inflation) shows eerie similarity to data back in 2001, some would argue even worse, it is the perspective from the supply side that is missing in most discussions. The 2000–01 crisis played out mostly in public markets and hurt the middle of the pack, retail investor. This is what created the spiral of failed internet stocks. What has changed now is that the private market has become the primary source of investment leading to companies staying private longer. And since the participants in these private markets are people with big pools of money, looking to satiate their desire for returns hitherto unfulfilled by public markets, their tolerance for risk is also higher. This allows the markets to absorb shocks like higher valuations, or companies going bust as well. This is why the threshold of what would constitute as dangerous territory would be a lot higher than 2001, and also defines, to an extent, the rules of the business for this generation (eg. deep discounting, something which old tech frowns upon).
What this closed market also does is, to a certain extent, that it contains the contagion whenever this new normal does go bust. This will ensure that the downward spiral spreads slower and to a far lesser number of people, both directly and indirectly, as the critical mass of the global population does not have the means to enter this market.
Therefore, when Mark or other people say that we are in a bubble or that this bust will be worse than the last one, one should take that with a pinch of salt,because even though the business fundamentals haven’t changed, the financing landscape has been turned on its head. Very quietly.