FRBSF Economic Letter
2000-07; March 10, 2000
California's IPO Gold Rush
The rush to find gold brought about 100,000 people to California from
1847 to 1849. A century and a half later, many Californians participated
in another rush to entrepreneurial gold. But this time, Californians prospected
for firms that would hire them as employees and allow them to share in
the bounty of a successful initial public offering (IPO) of equity.
This Economic Letter describes the IPO "Gold Rush" phenomenon
of 1997-1999 and provides "back-of-the-envelope" estimates of how much
equity wealth has been shared with employees of California firms with
recent IPOs. I estimate that currently more than 100,000 Californians
have employee equity stakes in firms that went public in the past three
years and that, on average, their stakes are worth several hundred thousand
dollars per person. The employees' good fortune owes partly to a surge
of venture capital funding that helped many California firms make it to
the public markets and also to the unusually strong aftermarket performance
of recently issued stocks in 1999.
Booming venture capital and IPO proceeds
Venture capital investments often help firms grow to the stage where
they are ready to make an IPO. For the past several decades, California's
share of the nation's venture capital investment activity has been disproportionately
large, in the 30%-50% range. According to the National Venture Capital
Association, this trend continued in 1999: the overall level of venture
investment in the U.S. surged, and California firms received about 43%
of that, or about $21 billion, up 186% from the prior year.
Last year also was remarkable in terms of the large number of California
firms making IPOs and in terms of the level of direct proceeds from these
offerings. Firms headquartered in California raised about $16 billion
in initial proceeds from IPOs in 1999, which is about five times the level
of IPO proceeds in the preceding year (Figure
1). The average proceeds per issue roughly doubled last year, and
the number of California firms with proceeds from IPOs also increased
sharply. The number of California firms with IPOs increased to 158 in
1999, up from 63 in 1998 and 102 in 1997. Cumulatively, this amounts to
323 California firms with proceeds from IPOs in 1997 to 1999.
Aftermarket performance of IPOs
When firms "go public" with an IPO, they typically distribute only a
fraction of the total shares in the company and retain the right to issue
additional shares to the public. The pricing in the public equity market
of the IPO shares reveals the value of the other ownership shares in the
firm and indicates the cost of raising additional capital. Thus, although
firms and their employees certainly are interested in the amount of the
IPO initial proceeds (the product of the number of shares offered times
the offer price), they also are concerned about the subsequent valuation
of the firm (the product of the total number of shares outstanding times
the aftermarket price). The success or failure of an IPO from the perspective
of the initial private owners of the firm, including employees with stock
and stock options, probably depends less on the initial proceeds and more
on whether high market valuations are sustained in aftermarket performance.
In 1999, the aftermarket performance of IPOs was phenomenally strong.
The beginning of the aftermarket period is the first day of trading in
the newly issued stock. From 1990 to 1998, the average return on the first
day of trading of IPO stocks in U.S. markets generally remained in the
10%-20% range (see shaded area, Figure
2). However, in late 1998 and continuing into 1999, average first-day
returns on many IPO stocks exceeded 50%. In fact, as noted by Ritter (1999),
last year was very unusual in that about one-fourth of the firms with
1999 IPOs in U.S. markets saw the price of their shares double on the
first day of trading.
Last year also was unusual in terms of aftermarket performance beyond
the first day. Historically, many newly issued stocks have either lost
value or underperformed seasoned issues in the first year. But last year
marked a break from the historical pattern. In 1999, a large proportion
of newly issued stocks sustained strong aftermarket performance well beyond
the first day of trading, and some of these stocks experienced such extraordinary
gains that the overall rate of increase in an index of the prices of stocks
issued over the previous twelve months was about 250% as of the end of
1999 (Figure 3).
The price performance of stocks with IPOs in 1997 to 1999 also was very
strong for the three years from 1997 to 1999 taken together, although
there was a bit of a dropback in 1998 that was overshadowed by the huge
gains of 1999. Individual firm data on the stock prices of the 323 California
firms that went public in these three years indicates that about two-thirds
of these firms experienced an increase in their stock price between their
IPO and the end of 1999.
As of mid-February 2000, the market capitalization of these 323 California
firms with recent IPOs was $676 billion. Most of this market capitalization
had been "created" in the last few years; that is, it represents increased
valuation, not just the initial public valuation of large, formerly private
firms or spin-offs from other publicly traded corporate entities.
Measuring how well employees may have
The 323 California firms with recent IPOs had 168,000 employees as of
the date of their most recent filings with the SEC. Many of these employees
were granted some equity interest in their employers and benefited from
the IPOs and strong aftermarket performance. Understanding the size of
this equity wealth is important to assessing the economic outlook for
California. Although the magnitude of this wealth effect cannot be estimated
precisely, I estimate the rough order of magnitude by drawing evidence
from various surveys and statistics on the prevalence of stock compensation.
Also, by explicitly delineating the logic of the computation, I give readers
a means to derive alternative estimates if they wish to alter any of my
individual (heroic) assumptions about some of the unknown parameters.
The first unknown parameter is the fraction of employees who have been
compensated with equity in their own firms. I assume that about 80% of
the employees (134,000 people) have some equity wealth from the option
or stock grant component of their compensation. This assumption is based
on the results from various recent National Center for Employee Ownership
(NCEO) studies of patterns in stock compensation. For example, one study
(NCEO 1999) reported survey results from 187 companies (primarily from
the San Francisco Bay Area) that have received venture funding and found
that 83% grant new-hire stock option awards to all of their employees,
while the remaining 17% grant options to key employees only. About one-half
of these companies also had ongoing option award programs for all employees,
but new-hire grants typically were the most valuable single grant of options
to employees. The study reports that stock options were the most prevalent
employee ownership practice in companies with venture capital backing.
ESOPs, 401(k) plans with matches in employer stock, and stock purchase
plans also are used by some companies to distribute ownership to employees,
but the NCEO notes that these types of programs are not as popular as
option plans in high-growth companies.
Estimating the fraction of firm stock held by employees of the firms
also is required. I assume that about 15% of the stock shares of the firms
have been distributed to employees. This is based on the 1998 NCEO Broad-Based
Stock Option Survey (NCEO 1998) result that West Coast firms had an average
overhang (total number of options granted and unexercised as a percentage
of outstanding shares) of about 15%. Although this fraction is on the
low side of possible estimates in that it excludes the substantial fraction
of shares acquired outright by founders and other early key employees
of the firms, this fraction is high by other forms of comparison. For
example, in contrast to firms with recent IPOs, large, established firms
tend to have much smaller fractions of employee ownership than 15% and
to grant fewer options on an ongoing basis; see Lebow, et al. (1999) for
a study of large firm stock compensation.
Options have exercise costs (strike prices), and in the case of employee
option grants, the exercise costs are remitted to the employing firms
when their employees convert the options into the actual stock. Thus,
the strike prices on the options are another important unknown factor
in the employee equity wealth estimating equation. I assume that the strike
prices were set at the value of the shares when the options were granted,
as this appears to be common practice among firms for various taxation
and accounting reasons. Furthermore, I assume that these initial values
are about one-third of the recent price of the shares, reflecting the
fact that IPO firm stock prices increased on the order of 200% during
the course of 1999. If 15% of the shares of these California firms are
in the hands of employees, but they must pay one-third of the value back
to the firms to exercise the options, then employees own about 10% of
the value of the firms via their option grants.
On a market capitalization of $676 billion for the 323 California IPO
firms, 10% is about $68 billion. Spreading $68 billion over 134,000 employees
with options implies an average net ownership interest of about $500,000
California has enjoyed an IPO gold rush during the past couple of years.
A recent surge of venture capital funding has helped many California firms
make it to the public markets, and the aftermarket performance of recently
issued stocks has been exceptionally strong. One important group that
has benefited has been employees at firms with IPOs. Even by the back-of-the-envelope
methods used here, it is apparent that many Californians have valuable
employee equity stakes in firms that went public in the past three years.
Lebow, David, Louise Sheiner, Larry Slifman and Martha Starr-McCluer.
1999. "Recent Trends in Compensation Practices." <http://www.federalreserve.gov/pubs/feds/1999/>
Board of Governors of the Federal Reserve System FEDS Discussion Series
Paper 1999-32. (accessed February 29, 2000).
National Center for Employee Ownership. 1998. "The 1998 NCEO Broad-Based
Stock Option Survey." <http://www.nceo.org/columns/news11.html>
Excerpts from the Employee Ownership Report (November/December).
(accessed February 29, 2000).
National Center for Employee Ownership. 1999. "New Survey on Stock Options
in Venture Capital-Backed Companies."<http://www.nceo.org/columns/news17.html>
Excerpts from the Employee Ownership Report (November/December).
(accessed February 29, 2000).
Ritter, Jay. 1999. "A Few Factoids about the 1999 IPO Market."<http://bear.cba.ufl.edu/ritter/ipodata.htm>
University of Florida (December). (updated February 2000, accessed February
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