For anyone investing today, crowdfunding is a big change from how companies have traditionally tapped the retail markets. Okay? But for an investor who was investing a 100 years ago, who somehow got a peek at what we're doing today, some elements of it wouldn't look so surprising. Okay? So, the internet would surprise them. Okay that's true, but companies going directly to the retail market with advertisements and with in cautious language, and celebrity endorsements, and then just taking whatever money they could raise that way, well, this was pretty much standard operating procedure if you go back more than a 100 years, until it's an accumulation of bad experiences and a fraud here and there started the regulatory process at the state, and then the federal level that has given us the protocol that we follow now for tapping the capital markets. When I think about how we go to the capital markets today and how crowdfunding compares to that, there's an English writer also from about a 100 years ago, one thing he said back I think it was 1929, he said and I paraphrase here, before you tear a fence down, make sure you know why it was there in the first place. All right. Before you tear a fence down, make sure you know why it was there in the first place. Right? So, crowdfunding is tearing the fences down around going to the retail public and raising money, and I see in some ways, bringing us back to where we were a long time ago. Not in every way and it's careful in some ways but there's a sense in which that's what's going on. All right. So, if we want to understand what crowdfunding is, how to think about this new regulatory environment, these new loosening of regulations on tapping this market, it's worth first seeing what it is, what it is we're doing now in the existing regulatory environment to facilitate raising money from the retail public. Okay. So let's think about the traditional IPO, Initial Public Offering IPO. So, let's say you're an entrepreneur and you've been very successful. You're so successful that you're thinking now it's time to go public. Okay? Now I'm ready to go out there and sell a piece of my company to the retail investor. Okay? So how do I do this? Well, the first thing I do is I'm going to engage an underwriter. Okay? An underwriter. Now, an underwriter is going to be big investment bank. I think Goldman Sachs, that kind of bank. I'm going to have probably little contest among investment banks. We call it a bake off. Right? Like someone's going to try to come up with the best muffin. Right? That's what they did. They call it a bake off in the investment banking world, where the different banks come to me and pitch to me how they're going to take my company public. How they think about my company, think about the valuation and so on. They pitch to me. I pick one of them and say, "Okay. It's going to be you and me. We're going to take my company public. " Notice by the way here that so now I'm engaging a bank that goes to the market all the time. Right? If I engage Goldman. Well, Goldman Sachs does a lot of IPOs. They've been doing IPOs all year. They've got a reputation with the capital markets that I don't. I'm just a start-up. They haven't yet heard of me probably but they will and when they hear about me, it's not just me, it's also Goldman Sachs or whoever the bank is that I choose, are sticking their neck out for my reputation. Right? So, we choose a bank with a long track record of doing IPOs and then what happens? Okay. Now, we start the process with the regulators. Okay? So now, together with the investment bank, we're going to work up a draft registration statement. So, it's something like a prospectus for an offering, but it's a draft and we send it to the Securities and Exchange Commission, and they get the draft, and they read it every word by word, and they send us back a letter which is going to have bullet points that are going to go on for pages, 50, 60, 70, 80, bullet points about you say this here, how do you know that, back it up, scale back, take it out, all these claims I want to make, they are holding me to task saying, you back this up or you take it out, or you scale it back, and I respond to all that. So I see all these bullet points. I send a new one, they look at that. More bullet points back and forth, could happen four or five times. All right. So, the document that is ultimately going to be presented to the public has gone through this very detailed scrutiny by the regulators. Okay? So then finally, I submit that document and that's going to be for the world to see. It's posted on the website of the Securities Exchange Commission. Okay? So I post that document and then we choose a price range. We haven't quite chosen a price yet, which is a price range could say we were thinking, $14 to $16 and maybe give us a sense of how many shares we're talking about. I think maybe a 100 million shares, $14 to $16. So, we make that announcement and then we go on the road show. Okay? So now there's a two week period where the executives of my company, me and my lieutenants, and also the investment bank, and they're professionals, and other people who are all traveling around the country, and we're going to go to other countries too meeting with the big institutional investors, where we are pitching our story and defending the price range that we announced, and they are going to bicker with us. We say what do you mean 14 to 16, and they'll have their own discussion of how that price compares to the price other stocks are already trading at. We're going to have a lot of back and forth. At the end of every meeting with the investors, they're going to express their interest in the offering, and when they express their interest, we're going to write that down in a book. It's called book building. This is called a book-building process because at the end of every day, at the end of every pitch you're going to say, you want shares or don't want shares. How many shares? What price? I write it down, and the book just builds, and I hope to have a lot more orders in the book than I actually have shares to sell. I would keep doing this, keep going, keep on like two weeks of this and then finally, at the end of all that, at the close of trading on some day, we say that's it, we are going to price the offering and the price doesn't have to be in that initial range, it's going to be somewhere around there. We choose the price and we place the shares with investors at that price, and then the next day it starts trading. Now one thing to notice here if you're a retail investor and you see a company going public, you see right now the big talk as I'm sitting here is LYFT, the ride share service. You're looking that, "I love LYFT, I want shares in the IPO, I think this is going great. Well, you probably won't get shares. You probably won't. The interaction on the road is all with institutional investors, that's where they're focusing on. If you have a brokerage account, you tell your broker, "Hey, get me some shares in that LYFT IPO." He might say, "Well, okay. I'll see what I can do," alright. Probably he'll come back and say, "No, no. You're not going to get shares in the IPO." If you are huge customer of that brokerage, then yeah, maybe if you've given a lot business, he'll say, "Okay, this is your lucky day, I'll give you 200 shares," something like that. But mostly what they're going to say is, "Just wait till it starts trading. You don't have to get them now, you can get them when they start trading." So you can do that, but let me just say a couple of things about that. Number one, when you see a company go IPO that offer price that they choose tends to be a very juicy bargain. On average, across all IPOs going all the way back to the 60s. If you look at every IPO and you do a little thought experiment, what if I invested at every IPO at that offer price they chose, and then just held it to the next day. The first day it starts trading, I just sell those shares I got. This is just thought experiment. If you look at what you would have made would be on average in one day 18 percent, the one day you return 18 percent. That's an average across the IPOs, so you might look at that and say, "Oh my God, that's great. It's hard to make five percent in today's world, this is 18 percent in one day." But in fact, your broker is not going to give you the shares. When he does give you the shares, if he ever does, if you're not a big customer but he said, "I can get you the IPO shares, this is your lucky day. I can get you the shares." Not only that they're a big bargain because remember they said 14 to 16 bucks? Well, they're pricing it at 12, right? They've discounted it, and I can get you shares at that disk, I can get you price shares at 12. Well, in that case that one is probably not going up 18 percent, that is the big red flag. In fact in IPO world, if they price it down from the initial price range they said 14 to 16 but on the big day they decide to price it at 12. That's not going up 18 per cent probably on average, that means it's probably going to go nowhere in the first day. It's the ones they price up actually are the ones that really do great. So you're not going to get it as a retail investor, as a retail investor you're not going to get it on at IPO price. You can buy it in the aftermarket when it starts trading. But actually, that tends to be not a bargain really at all. In fact, it's well-established that on average if you look at stocks that have gone public, if you buy them on the aftermarket where they're trading on average over the next couple of years, there average return is actually kind of below the market. IPO sort of under-perform once they start trading for a couple of years. So it's not really that exciting to get in on the IPO in the aftermarket. But of course you could buy a stock that goes to the moon. If you bought Google or Facebook or whatever after their IPO, that would be terrific if you held onto those shares. So obviously, in any point you can buy a winner stock but it's really getting in at the IPO price that is so attractive and as a retail investor that's not going to happen. So that's just a sketch there of how we go public, right. There's a lot of regulatory scrutiny with all the documents that you are presenting to the public. You're engaging an underwriter who has tremendous experience and reputation with the capital markets. So that's what it's like for the its point of view, from the retail investors point of view IPOs are fun to watch, but it's not really something that you're going to participate in and you can buy like anyone else, you can buy it once it starts trading. So bear that in mind. Here's one other interesting fact, which is that the number of IPOs is way down. So what I mean by that is, when I started teaching here at the Wharton School since the mid 90s. I've been here since the mid 90s, the mid 90s number of publicly listed companies was over seven thousand, that's like 7200 publicly listed companies in the US. That had been going up and up and up and it seemed as natural. Well, of course it's just going to keep going up as the US population grows. Naturally, you think the number of publicly listed companies would grow. So the number of publicly listed companies is today half of what it was about 25 years ago, so you think from the retail investors' point of view just the scope of choice. Where am I going to put my money? What are the opportunities out there for me to take a view on some stocked to get in on a ground floor to make an exciting investment? Well, it's half as many stocks as they were, and I think about why that might be. Well, of course it's easier for companies to stay private these days. Think about Uber, I said LYFT. LYFT is gone public while Uber isn't and hasn't, and they've been private for a long time you could think of a lot of other companies like them staying private. You have a lot of companies also that maybe was never even their goal to go public these days that their goal is just to get big enough maybe they'll be a threat to Google, or Facebook, or Apple or some company like that and then just sell out to them. So by the time they're ready to sell, well they sell out to a big company and you never even got your chance because they just sell out to public company, that's for average they're going to be a very small part. Sort of the investment opportunity set has shrunk over the years, and this has made life more difficult for the retail investor to put their money to work in a way that they find interesting or promising or that they enjoy. So just to summarize what we've said here, the status quo of raising money from the capital markets when you go to the retail, public, I do that through the IPO process in which the retail public really barely plays any role at all. I do this through tight scrutiny by the regulators through engaging an underwriter with a big reputation. This has worked recently well over the years but it's also come way down as a part of the capital markets, many fewer IPOs than there used to be, many fewer publicly listed companies that used to be. That is the context in which Congress rolled out the Jobs Act of 2012.
