Why Sarbanes-Oxley Was the Best Thing That Every Happened to the Internet

In the next year or two, we’ll likely see the following companies go public with an initial market value over $10bn:

• Facebook
• Groupon
• LivingSocial
• DropBox
• Zynga

Many of these are companies that, in a world without Sarbanes-Oxley, could already be public. That would probably be good for investors; if average people could have gotten Facebook stock at the same $500mm valuation their Series C had, it would have been a spectacular investment, indeed.

Or would it have been? Counterfactuals are notoriously tricky, but it still seems that most of the companies listed above are incredibly ambitious. Whereas today’s mid-tier dot-coms are all fairly boring. Stamps.com, Ancestry.com, and Quinstreet are all pretty good businesses, but they’re also pretty boring. Good, boring businesses are great at hitting their quarterly numbers, but they’re not so great at providing an incredible user experience or transforming an entire market.

When companies are restricted to accredited investors—and big accredited investors, at that—they think differently. They care less about the next quarter, and more about getting a 10X return for their early backers, or a 3X return for funds providing growth capital. Illiquidity isn’t a net positive, but it does force investors to think about the bigger picture, which also forces entrepreneurs to think that way.

This trickles down to consumers, too. Publicly traded Internet companies innovate much more slowly, at least as far as users can see. (Public companies that invest heavily in R&D—Microsoft, IBM, Google, and the like—also tend to invest disproportionately in the “research” side. It pays off, but over a very long time.) Projects like the News Feed and Groupon Now are harder to imagine from a public company.

Sarbox has also dampened acquisitions by removing the public market as a competing bidder. The biggest effect here might be that investment banks have less of an incentive to build relationships with early-stage startups in the hope that they can take those startups public years later. This gives startups less access to acquisition offers and less negotiating leverage. All that might lead to more total acquisitions (since acquisitions are a good substitute for an IPO when someone really wants to cash out), but fewer exits.

Sarbox was bad for entrepreneurs. But it was bad for entrepreneurs in a way that’s good for consumers and late-stage investors: it forced founders of great companies to double-down on world domination instead of settling for life as a boring public company or a subsidiary of Microsoft.

And now it’s finally paying off. We’re getting a new crop of actively fascinating Internet IPOs—the first time we’ve had so many since the last bubble.

(Mark Suster has related thoughts on VCs responded to public markets. Naturally, this piece about VCs responding to a down market was published the morning of a 5% rally.)