NASDAQ And SOX Versus LSE (NDAQ, LSE.L)

Lost in a lot of clutter, was last week's announcement by NASDAQ (NDAQ) that it was ceasing to pursue its acquisition of the London Stock Exchange (LSE.L). Interestingly, the LSE's stock surged after the courtship ceased. Maybe the market understands something!

This pushed me to finish a post I have been working on for a while on the battle between London and New York as the IPO market of choice. What? London as an IPO market of choice?

Having been around the VC business for about 10 years, I have come to appreciate that VCs often see leading indicators of technology and market changes. Early stage investing tends to give you that perspective. Based on my conversations with VCs and companies, I think I can say that I now have a leading indicator on stock market selection as well and the tide is definitely turning eastward.

In fact, it may have already turned: According to the Red Herring, "Europe attracted five times as many non-European companies to its exchanges as the U.S. Some 126 overseas companies listed on European exchanges in 2005, raising €€9.6 billion ($11.4 billion)." And, according to Thomson, non-U.S. IPOs (My strawberry patch, Israel, falls into that category) on the LSE raised over $16 billion this year, compared to $3.4 billion on the NYSE.

Why are so many companies talking up London as an IPO alternative? This is what I am hearing from entrepreneurs, CEOs and VCs.

1. Sarbanes Oxley - This has already been widely reported (see Red Herring article above and others). While Enron scandalized everyone, the pendulum of oversight and compliance has swung way to far against the entrepreneurs and CEOs. Costs and headaches associated with SOX compliance are balooning. See this excerpt from a recent article in the Boston Business Journal about Massachusetts companies to get an indication:

The pundits were wrong. A Boston Business Journal analysis of 27 public companies in Massachusetts shows their auditing costs spiked 26 percent last year, bringing their total increase to 103 percent since SOX became effective in 2004. In total, the group spent $56.6 million on SOX and related auditing costs last year, or around 2 percent of their 2005 operating income.

That is over $1 BILLION in market cap (assuming a 20 P/E multiple which is conservative for IPO companies) for Mass. companies alone, and it does not include internal costs and staffing (Read the whole article; it is worth it).

These next two are less obvious to outsiders and not well-reported.

2. In London and on the LSE, liquidity is king. Investors there want you to have a big float on the company and, as such, place less importance on lock ups and founder sales. It is pretty attractive for a founder, who has toiled for years with relatively little remuneration, to take some money off the table on the IPO day. Compare that with the draconian lock-ups imposed by underwriters taking you public onNASDAQ and you can see why one would look to London.

3.Thee LSE only requires half-yearly reporting. That is a 50% reduction on the US requirement! Quarterly reporting in the US is a big management distraction and it is expensive. It also makes management focus on very short term goals. Reporting every six months, while not a panacea, certainly eases the burden and lets you think a bit more long term. I would even argue that it reduces some incentives for fraudulent activities such as end of quarter channel stuffing.

Don't get me wrong, there are still some dis-incentives to going to London. On the whole, there is less liquidity than in the US and if you have a hyper growth company, you will get a lower multiple in London (although the thrashing a stock takes for missing numbers in London is more muted as well). However, with a tepid US IPO market for start-ups and powerful dis-incentives to go public in the US, I think this leading indicator will show us more and more IPOs in London over the coming years.