Sil­i­con Val­ley Tries to Build A Bet­ter Stock Ex­change

▶▶The Long-Term Stock Ex­change could dis­cour­age quick trades and re­ward bet­ter de­ci­sions ▶▶“You’re ad­ver­tis­ing to the mar­kets that you’re will­ing to be held to a higher stan­dard”

Bloomberg Businessweek (Europe) - - TECHNOLOGY -

When Eric Ries showed friends a draft of his 2011 book, The Lean Startup, some ad­vised him to get rid of a sec­tion propos­ing the cre­ation of a stock ex­change for tech com­pa­nies that would dis­cour­age short-term think­ing. It would ruin his cred­i­bil­ity, Ries says they told him. Ig­nor­ing them, he kept the sec­tion in. The book, a guide for build­ing suc­cess­ful com­pa­nies, went on to be a best-seller and made Ries a cult hero among tech en­trepreneurs.

While read­ers em­braced his “fail fast” ap­proach to get a “min­i­mum vi­able prod­uct” in front of cus­tomers as quickly as pos­si­ble, no one picked up on his stock mar­ket pro­posal. So five years later, Ries has started build­ing the Long-Term Stock Ex­change him­self.

At first, bankers, in­vestors, ven­ture cap­i­tal­ists, and reg­u­la­tors told him the idea was too far out­side the sta­tus quo to work. “Peo­ple treated me like a bar­bar­ian,” he says. Even­tu­ally, though, he per­suaded a team of about 20 en­gi­neers, finance ex­ec­u­tives, and at­tor­neys to join him and raised money—he won’t say how much—from about 30 in­vestors, in­clud­ing ven­ture cap­i­tal­ist Marc An­dreessen and technology evan­ge­list Tim O’Reilly.

Launch­ing the LTSE won’t be easy: Get­ting ap­proval from the U.S. Se­cu­ri­ties and Ex­change Com­mis­sion could take sev­eral years. Ries is in early dis­cus­sions with the agency. The next step will be to file an of­fi­cial ap­pli­ca­tion de­tail­ing his pro­pos­als, such as the list­ing stan­dards, fol­lowed by a 90-day public com­ment pe­riod. The reg­u­la­tor’s de­ci­sion whether to green­light the ex­change could take months.

Ries ar­gues that ex­ist­ing ex­changes en­cour­age bad de­ci­sion-mak­ing by com­pa­nies, in­vestors, and

em­ploy­ees. The prob­lem, he says, begins with stock mar­ket in­vestors who fa­vor com­pa­nies that show big in­creases in sales, prof­its, users, or other mea­sures ev­ery quar­ter. When a com­pany falls short, in­vestors flee, and the stock plum­mets. Hop­ing to avoid such jolts, man­agers spend too much time fo­cus­ing on short-term per­for­mance. Ries says he’s heard the same story many times: Half­way through a quar­ter, an executive re­al­izes the com­pany isn’t on track and starts slash­ing in­no­va­tive pro­jects to meet his num­bers. Once a com­pany goes public, he says, em­ploy­ees “are on Ya­hoo! Finance ev­ery day, and it’s pal­pa­ble how much that’s af­fect­ing the de­ci­sion­mak­ing of or­di­nary man­agers.”

Af­ter many dis­cus­sions with com­pa­nies and in­vestors on how to com­bat those ten­den­cies, Ries de­cided his ex­change would have rules tar­get­ing three areas: how ex­ec­u­tives are paid, how com­pa­nies and in­vestors share in­for­ma­tion, and how in­vestors vote. A com­pany that wants to list its stock on Ries’s ex­change will have to choose from LTSE-ap­proved com­pen­sa­tion plans de­signed to make sure executive pay isn’t tied to short-term stock per­for­mance. Ries com­plains it’s com­mon to see CEOs or top management get­ting quar­terly or an­nual bonuses tied to met­rics such as earn­ings per share, which pushes them to goose the num­bers with ac­count­ing gim­micks or other ploys. Ries wants to en­cour­age com­pa­nies to adopt stock pack­ages that con­tinue vest­ing even af­ter ex­ec­u­tives have left the com­pany.

The LTSE also wants com­pa­nies to share more in­for­ma­tion, such as de­tails on re­search and development spend­ing. And to mod­er­ate swings in a com­pany’s stock price and in­crease the in­flu­ence of pa­tient in­vestors, share­hold­ers who hang on to their stock would see their vot­ing rights in­crease over time. As Ries sees it, an LTSE-listed com­pany will have an ex­tra stamp of ap­proval. “You’re ad­ver­tis­ing to the mar­kets that you’re will­ing to be held to a higher stan­dard,” he says.

Ries’s re­forms may not have the in­tended ef­fects. For ex­am­ple, grant­ing greater vot­ing rights to long-term share­hold­ers would make takeovers harder, and that could end up pro­tect­ing com­pla­cent man­agers, says Larry Har­ris, a pro­fes­sor of finance and busi­ness eco­nomics at the Univer­sity of South­ern Cal­i­for­nia. “The threat of takeover has done far more to get good be­hav­ior out of cor­po­ra­tions than per­haps any­thing else,” he says. “A so­phis­ti­cated in­vestor may shun” an ex­change that cre­ates ob­sta­cles to out­siders who want to shake things up.

Get­ting SEC ap­proval is “a fairly painful process,” says Sang Lee, man­ag­ing part­ner at Aite Group. Like Ries, Brad Kat­suyama, a hero of Michael Lewis’s Flash Boys, is try­ing to ad­dress what he sees as the short­com­ings of ex­ist­ing mar­kets. Kat­suyama has spent the bet­ter part of a year try­ing to get SEC ap­proval for IEX, his al­ter­na­tive stock trad­ing sys­tem de­signed to neu­tral­ize the im­pact of high-frequency traders. He faces re­sis­tance from ex­changes such as the NYSE, which slammed IEX’s pro­posed ex­change as “un­fair” and “opaque” in a Novem­ber let­ter to the SEC. If Ries gets the go-ahead from

the SEC, he will face what may turn out to be his big­gest chal­lenge: per­suad­ing a com­pany to be the first to list on the LTSE.

Ries isn’t court­ing Uber, Airbnb, or gi­ants that are still pri­vate. In­stead he’s con­nect­ing with mid­size startup founders, some of whom have in­vested in the LTSE. In the next few years, Ries hopes a hand­ful of these com­pa­nies will emerge as strong IPO can­di­dates. If he’s lucky, one will de­cide to take the plunge. “As an in­dus­try, we all want to see these changes hap­pen, but there’s al­ways a lit­tle bit of an in­cen­tive for any in­di­vid­ual ac­tor to say this isn’t my fight,” Ries says. “I don’t be­grudge those peo­ple. But if ev­ery­one does that, change doesn’t hap­pen.” Ellen Huet and Brad Stone, with An­nie Massa

The bot­tom line Launch­ing the Long-Term Stock Ex­change, a new ex­change for tech com­pa­nies, could take sev­eral years.

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