Ch.9 Going Public
Ch.9 Summary
- An IPO is a pipe dream for all but a few corporations - An IPO brings much-needed cash to a growing company and, for its owners, an opportunity to liquidate and diversify their wealth - The downside of an IPO is its expense, absorption of management time, dilution of ownership, ongoing public scrutiny, and pressure to produce short-term gains - Consider the right time to go public, weighing current market conditions as well as your interest in keeping control of the company. - Don't consider an IPO unless your corporation has these qualities: a CEO who knows how to communicate, a deal size of $10 million or more, a record of double-digit growth in rev- enues and earnings (or earnings clearly ready to follow), outstanding and difficult-to-copy products or services, quality employees, and a logical strategy for growth. - From the perspective of a cash-hungry US corporation, there are eight steps to an IPO: selecting an underwriter, preparing and filing a registration statement with the SEC, con- ducting due diligence, distributing a preliminary prospectus (a red herring), mounting a road show by top management, determining the share price and number of shares in the issue, beginning trading, and closing the purchase and sale of shares. - An investment bank provides two important necessities: the technical knowledge for getting the deal through the registration process and the sales network needed to distrib- ute the company's shares to the investing public. - A private placement is often a good alternative to an IPO.
Alternative to an IPO
An IPO can be just the thing a growing company needs to expand to its potential. But very few companies have the size or growth potential for this type of financial if financing. Some enterprises are in industries so out of favor with the investing public that the deal would have few takers. Still other companies deliberately forgo IPOs to avoid the problems associated with going public. Are these companies cut off from substantial equity capital? Are their current owners unable to harvest their investments? The answer is no. There are alternatives to an IPO: sale of a large block of equity via a private placement, and sale of the company itself. We'll consider the first of these alternatives in this chapter and examine company sales in a later chapter. Alternatives: Private Placement Warrant
The IPO process in a nutshell - Steps
Now that you understand the pros and cons of going public and whether your firm is a candidate, let's take a look at the process itself. That process has several steps; some must be conducted sequentially, whereas others can be handled in parallel. Very briefly, these steps are as follows: 1. Select an underwriter The underwriter - the investment banker you choose will handle the details in collaboration with the management team. In larger deals, there will be one lead underwriter and one or several comanagers. 2. Prepare the registration statement for filing with the SEC The registration statement, a document required by federal law, forces the applicant company to disclose past business results, information about the company, and the intended use of the proceeds of the IPO 3. Conduct due diligence In the case of IPOs, due diligence is the investigation of facts and statements of risk contained in the registration statement; it aims to ensure that this material is accurate and that other relevant facts have not been omitted. Is the company using an unorthodox accounting convention? Is it involved in any current lawsuits? Has it been granted patents, or are patents pending? Due diligence is the responsibility of those who prepare and sign the registration statement. 4. Print and distribute the prospectus The preliminary prospectus (also called a red herring) is part of the registration statement. It contains information about the company and the intended use of the issue proceeds, and it is sent to prospective investors to generate interest in the deal. 5. Prepare and conduct a road show At a series of meetings, usually helps in major cities around the country, potential investors can grill the CEO or CFO (or both) about the company and the intended offering of securities 6. Agree on a final price and the number of shares to be sold This step is one of the most important steps in the IPO process. What is a fractional share of ownership in a company actually worth? Important as this question may be, the answer is based as much on art as on science. A price range will be indicated in the prospectus sent to investors - for example, $15 to $20 per share. As the big moment approaches, however, the underwriter will look at demand for the shares, the price that comparable companies managed to get in recent IPOs (if comparables can be found), and the projected earnings of the company itself. The underwriter will also suggest a price that will give investors in the newly issued shares a better-than-even chance of making money on their transactions - that is, a price slightly lower than the price at which the shares are likely to trade in the days immediately after the offering. If the issuing company doesn't not like the price, it can put the brakes on the offering. 7. Commence Trading After the price has been established and the final regulatory loose ends have been tied up, shares can begin trading on the exchange chosen 8. Close the purchase and sale of the shares In this final act of the IPO process, stock certificates are delivered to the shareholders, and the underwriter delivers the proceeds (less fees and expenses) to the issuing company. The company now has its money.
Warrant (Alternative to an IPO)
Security that gives the holder the right to purchase common shares of the warrant-issuing company at a stated price for a stated period. The stated price is generally set higher than the current valuation of the shares
Private Placement - Can take several forms (Alternative to an IPO)
senior or subordinated debt, asset-backed debt, and equity. Because these are private deals the company and the investor may be able to work out arrangements that suit both parties For example: if the company prefers debt, but the investor insists on an opportunity to share in the firm's upside potential, an investment banker might design a debt instrument with a below-market interest rate (good for the company) but with warrants attached (good for the investor).
Any company contemplating an IPO
should understand both the promise and the negative implications
The making of an IPO candidate
Do the benefits of being a public company outweigh the drawbacks? Sometimes they do, and sometimes they don't. Even if they do, your enterprise may not be a candidate for an IPO. In fact, an IPO is a pipe dream for all but a small percentage of corporations. This section recounts some of the factors you need to consider before counting your enterprise as an IPO candidate.
This process generally takes (The IPO process in a nutshell - Steps)
Four to five months. If all has gone well, the ent. firm ends up with a substancial amount of cash in its war chest and is prepared to begin the second stage of its life - that of a publicly traded corp. The underwriter wil try to support that second stage by providing ongoing research to investors on the newly public company. This research keeps the company in the public eye and, if the news continues to be good, it supports the share price. There is more to the IPO process than described here. For example, there are restrictions on company-generated publicity before, during, and immediately after the filing period and on so-called lockup agreements, or the sale of shares by insiders. The rules regarding the issuing of securities in the U.S. are, indeed, many and arcane - and that is ehy professional help is essential. First-person overview of the IPO process - and the excitement it generates - look at image
Pros of an IPO
Gaining personal wealth (and liquidity of that wealth) is one of the benefits of going public, but it is not the only advantage. At the same time, the cash that flows onto the company's balance sheet from the IPO has these effects: *Costly interest-bearing debt can be paid off *The company has the financial capacity to develop new products and the marketing capabilities to sell them *An improved debt-to-equity ratio enables the company to obtain debt financing on better terms than otherwise would have been possible, if the company needs this financing *The company can use cash and its own marketable share to finance strategic acquisitions * The financials stability of the enterprise is improved, enabling it to attract talent, suppliers, and joint-venture partners * Becoming a public company opens the door to future rounds of financing through stock and bond sales Note: An IPO does not give absolute liquidity to company insiders. US securities regualtions place restrictions on the sale of insider-owned shares
An investment bank is not like the more familiar commercial bank (The role of the investment bank)
It is not in the business of taking deposits and making loans. Instead, it acts as an agent and a deal maker for business entities seeking capital. In return for a fee of 6 to 10 percent of the offering price, the investment banker does the following: 1. Helps the issuing corporation get its regulatory act together Specifically, it helps the corp. over the stringent regulatory hurdles that go in hand with issuing securities. These hurdles include the development of a prospectus. In its preliminary form, the prospectus provides full disclosure to potential investors about the company, its business, its finances, and the way it intends to use the proceeds of its securities issuance. A mentioned above, the preliminary prospectus is called a red herring. 2. Sets the price of the securities being offered When shares are being offered to the public for the first time, no one knoes for certain how they should be priced. Those shares haven't been traded back and forth by willing buyers and sellers, so there is no certainty as to the market-clearing price. The capital-seeking corp. naturally wants its shares priced as high as the market will bear; doing so maximizes the cash going into its coffers. But investors expect a new issue to be priced are a bargain relative to seasoned securities. The investment banker has a expertise in this difficult pricing area and mediates between these disparate interests. 3. Arranges for the distribution of shares The issuing corp. may have the shares, but the investment banker has access to potential purchasers. BY putting a syndicate of distributing broker-dealers together, the investment banker can "move the merchandise" into the portfolios of pension funds, mutual funds, and individual inventors. The investment bank usually takes the shares the shares off the hands of the issuing corporations at a given price, marks them up to some predetermined profitable level, and uses its own distribution channels and those of its syndicate partners to sell them to be investing public. In this sense, the investment banker underwrites the risk of selling hundreds of thousands of shares.
Going public is a specialized activity (The role of the investment bank)
One the unique skills and capabilities that no ent. company has (Or should have) on its payroll. Instead, you'll get these skills and capabilities through an investment bank. More on why you need an investment banker in the image
Private Placement (Alternative to an IPO)
Refers to the sale of company stock to one or a few private investors instead of to the public. In many cases, these private investors are sophisticated financial institutions such as insurance companies, pension funds, and endowment funds that seek a higher return than could be obtained from public investing. A key benefit of this alternative is that these deals are exempt from SEC registration requirements (although some states do have requirements). Thus, the entrepreneurial firm can obtain a sizable piece of capital without the time and expense of a public offering. Nor will its management and business results be subject to the public scrutiny that follows an IPO/
In a study of successful IPOs, another trait (The making of an IPO candidate)
That few would consider a condition of making the transition from private to public company. It found that successful companies began acting like public companies long before they did the deal. These companies made improvements in their employee incentive programs...in strategic planning, internal controls, financial accounting and reporting, executive compensation, and investor relations policies. Investors in these firms were buying ownership in a firm that already had the hallmarks of professional management.
Cons of an IPO
The proceeds from an IPO provide important benefits for owners and investors, but as many CEOs and chief financial officers (CFOs) will attest, public company status is a mixed blessing. Here are the most important drawbacks of becoming a public corporation: * The IPO expense Just getting the IPO through SEC registration and off the ground generates major legal, accounting, printing, and advisory expenses. Then there are SEC and state securities filing fees payments to the exchange that lists the stock. A company should expect to pay $2 million in out-of-pocket expenses when preparing for an IPO; the amount can soar to $100 million for larger deals. These expenses cover legal fees, commission to the underwriter, and any improvement of internal business processes to meet regulatory requirements as a public company going forward. * Management time and attention The preparation that goes into an IPO absorbs an enormous amount of top management time and attention over several months. So too does the road show, which takes the CEO and CFO on a time consuming and costly jaunt to investor meetings around the country. Even after the deal, these two officers must devote part of their time to handling inquiries form investors and security analysts. The company may have to create a position for an investor relations manager to deal with these new stakeholders. * Public Scrutiny The company is now an open book. Its financial results and the compensation of key executives are available to anyone who is interested. The company's 10-K filing will contain information that competitors are bound to find valuable; the names of key suppliers, product-development plans, overall strategy, and so forth * Loss of Control When an enterprise sells shares to the public, the founder and key managers usually lose a major portion of their ownership. Outsiders - mostly institutional investors - now own blocks of your company's stocks. And there may be thousands of small owners with fewer than one thousand shares. * Pressure for short-term gain Although most CEOs deny it, the expectations of analysts and investors for predictable year-to-year earnings gains can put decision makers in a difficult position. They may be reluctant to take steps to ensure long-term benefits if doing so will short-term results.
Through most of the post-World War II era (The making of an IPO candidate)
US companies didn't go public until they had established a solid record of sales and earnings. After all, investors in an IPO are asked to buy shares of a money-making machine; they want evidence that the machine actually works The conservative practice of requiring a record of sales and earnings is occasionally set aside when a company owns proprietary technology and has a tested management team. In these cases, investors are willing to gamble that the company's potential will produce profitable results. During rare periods - the dot-com boom of the middle to late 1990s being one - companies with nothing more than a clever idea were able to sell initial public shares. Many of these companies failed to demonstrate their worth in the years that followed, and the effects of that experience still affect the IPO process today. ^^Thus, the ability to launch a public offering is partly a function of investor moods and expectations, combined with the ability to meet regulatory requirements. Typically, however, entrepreneurial firms need these characteristics to be viable IPO candidates: - A reasonable deal size. Given the cost of launching an IPO, there's little point in seeking less than $10 million. And if you're raising that much money, you must have a solid plan for using it. - Evidence of growth. The firm should have growing sales, with evidence that earnings will follow. Investors expect rising stock prices from double-digit growth in sales and from a higher rate of earnings growth. If the earnings record isn't yet there, all signs should point to substantial profitability in the years ahead. This growth should support a price-earnings multiple (also called the P/E ratio) higher than the historical S&P 500 or Russell 2000. - Outstanding products or services that are difficult to copy - A credible CEO who can communicate the enterprise's vision to cautious outsiders - At least three years of audited financial statements (if you don't have them now, you can create them through a "look-back," provided you have solid enough records) - High-quality employees - A logical strategy for growth and a predictable revenue stream - And another one that most wouldn't consider... successful companies began acting like public companies long before they did the deal
Growing firms with exceptional revenue
have another option to achieve a significant cash infusion: they can seek financing through an IPO. This process presents ownership shared to the world of individual investors and institutional investors such as pension funds and mutual funds and results in a significant exchange of paper ownership shares for the hard cash the company needs for stability and expansion. **IPO marks a major milestone in the life of a company. It signals that your enterprise has earned the confidence of people outside its inner circle of participants - it has "made it." Going public also makes your company accountable to a much broader universe of stakeholders, analysts, and regulators.**
Requirements for going public are
high...only a tiny fraction of startup companies ever go public. the conventional rule of thumb is that a company needs around $100 million in annualized revenue as well as several consecutive profitable quarters. Few entrepreneurial companies ever reach this bar and get to the point where an IPO is either necessary or feasible. Despite this, the rewards of this form of financing make IPOs intensely interesting to company founders, key employees, and early-stage contributors of capital.
One of the biggest questions for a growing company (Preparing for an IPO)
is when to file for an IPO. To soon , and you may not make the most of your company's potential; too late, and you may miss a bullish investment market. The image: "When to go Public" presents the story one successful CEO told about deciding when to do it and how the company made the most of its preparation period
To choose an investment banker (The role of the investment bank)
you'll probably have 3 to 5 candidates make presentations to you and your leadership team. You should look for a good fit with your industry. They should also have the sales and distribution capabilities you need and should be able to provide good analyst coverage for you once you go public. You'll also be interested in their take on the current market and what they think your valuation should be - and confirmation that they agree that you are ready to go public.
Weighing the decision to go public
you've probably read many accounts of founders and key employees of entrepreneurial companies who had quite ordinary financial circumstances the day before their firms went public. By the same day, those same individuals were millionaires eBay example
