Graziadio Business Report - Initial Public Offerings


		The year 1999 was the year of the initial public offering, or IPO. There was a near record in terms of the number of IPOs, but even more impressive was the amount of capital raised. More than 45% of IPOs were priced above the initial target price range filed with the SEC. Moreover, the average 30-day return after the IPO was an astonishing 97%. With returns like that, who wouldn't think of taking their company public? In fact, the biggest gainer during 1999, Va Linux Systems, increased 697% on the first day of trading and ended the first 30 days with an overall 167% gain. Incredibly, though, if you have not yet taken your firm public, you may not have missed the boat. Although it remains to be seen what effect the recent volatility in the market will have, so far during 2000 the pace is even higher. Through the first quarter of 2000 there were 140 IPOs, whereas during the same period in 1999 there had only been 71. Furthermore, the average IPO size, in terms of dollars raised, is increasing. In 1996, it was $60 million; in 1999, $130 million; and so far in 2000, it has increased to about $225 million. Whether it will continue at this pace is anyone's guess, but this may well be as good a time as there will be to go public. Whether you are thinking of an IPO in the very near future or a bit further down the road, however, there are some important points to consider. The goal of this article is to provide critical information to assist you in determining whether the time is right for your company to go public. This includes summarizing the benefits as well as indicating the costs that you should anticipate. Is the Time Right? In terms of the number of IPOs, 1996 was the historical "high water mark." There were 758 IPOs in 1996 that raised approximately $45.5 billion, or an average of $60 million per firm. There was a steady decline for the next two years, as shown in Figure 1 below, with the average raised per firm declining all the way down to $10 million in 1998. Then came the explosive growth of 1999, both in terms of the number of firms going public and the amount raised. Additionally, the 30-day post-IPO performance took off from a low of 14% in 1997 to the 97% registered in 1999 (see Figure 2). Although 2000 is still young, through March that return increased again to an unbelievable average of 144%. Figure 1 Figure 2 As you might suspect, technology stocks were the major driver of these returns, as 78% of IPOs in 1999 were technology related. As shown in Figure 3, Internet and software and communications companies comprised 66% of all IPO deals. The early statistics for 2000 indicate that the percentages are similar. When the 30-day returns are partitioned into the same industry segments, Figure 4 confirms that the large overall returns in 1999 are due primarily to those same two groups, although the communications sector has the higher returns. While the 40% returns for consumer and financial sectors are large by historical standards, they pale in comparison to the current returns in the other sectors. As one last indicator that the time may be right to go public, in one subset of technology stocks, business-to-business (or B2B), the 30-day returns for year 2000 IPOs averaged 184%! Figure 3 Figure 4 Obviously, not every deal generates returns like these. But if your company is in any of the "hot" segments, you should be aware that returns like these cannot continue indefinitely. To decide if this is the time for you to try to realize these potential returns, you need to understand what is involved in the process of going public. The following section will provide an overview of that process, indicate the approximate cost, and list some of the downsides of being a public company. On the Road to an IPO From an overall perspective, there are three general steps in the IPO process: 1) resolving issues in planning for an IPO.2) going through the procedural process of actually doing an IPO, and 3) doing the "roadshow." Technically, the roadshow is part of step 2, but it is such a major element and time consuming process that it will be treated separately. The remainder of this installment will provide details about step one. Steps two and three will be covered in the summer issue of the Graziadio Business Report. Planning issues: Before initiating the actual IPO process, you need to spend quality time thinking about and resolving the following issues. The answers to many of these questions are important because they will be incorporated into the Registration Statement that is filed with the SEC and made available to potential investors of the stock: Size and timing of the offering: To provide sufficient compensation to the various parties involved in taking your company public, the proceeds should be at least $50 million. If management determines that it cannot reasonably justify need for that minimum amount, then venture capital may be a better alternative. Selection of the team: In addition to company personnel, the team includes the underwriters, attorneys and outside accountants. The primary goal is to not only hire professionals that understand IPOs, but who also understand your industry. The underwriters are the most important player because they will be finding the initial investors and providing price stabilization for about 30 days after the offering. It would be wise to solicit presentations from several investment banks, from small to large. The attorneys' main role is to make sure that the legal documents conform to legal standards, and there are many choices of reputable firms that can be recommended by the underwriters. The auditors want to make sure that the information provided to potential investors is as accurate as possible. The "Big 5" firms (Ernst and Young, Arthur Andersen, PriceWaterhouseCoopers, Deloitte and Touche and KPMG Peat Marwick) control about 90% of the IPO market, so choosing one of these firms will help provide the needed credibility. "Make-over" to a public company and positioning: The informational demands on a publicly held company are significant. After consulting with the potential members of the team, it may be recommended that you alter or change the company name, streamline the product offerings and/or refine the market focus to be able to better communicate the essence of the company to the public marketplace and maximize its value. Management team: The pre-IPO planning process is a good time to evaluate the skills and capabilities of top management in a firm. Anyone currently at his or her maximum potential may not be able to help lead the firm to higher levels of achievement that shareholders will expect. Current owners and/or the Board may need to identify existing employees with these skills or hire a qualified outsider. Especially if the founding management is still in place, this may be difficult. In any event, the management team must be in place and functioning smoothly well prior to the IPO to assure potential investors that the leadership of the company is on solid ground. (The management team and the Board will also be described in the offering prospectus.) Board of Directors: SEC regulations require that at least two members of the company's Audit Committee (or Board, if there is no separate Audit Committee) be independent outsiders in order to provide assurance of objective top-level leadership of the firm. In other words, the company can no longer be simply and solely family run. One potential cost to being a public company is that, while you may start as Chairman of the Board and Chief Executive Officer, unsatisfactory performance can result in your being removed from one or both positions. Market/industry/sector conditions: Due to the lead times involved in going public, it may not be possible to hit the exact right time in terms of maximum funds raised. The company's investment banker can be helpful here in identifying trends. On the positive side, while the current bull market is very volatile, most analysts see few signs that it is really over, so a delay of a month or two may be inconsequential. If, however, there are serious downturns in the market during the IPO process, management should be ready and willing to postpone the offering. Valuation expectations: The recent trend has been to select a conservative price range for the offering prospectus, test the waters, have the final offering price 20% - 30% higher, and then have the post-IPO price really "pop" to add additional visibility and excitement about the firm. In other words, having an IPO price too low is far better than having one too high. Next to helping the company actually market its stock, assisting in setting the "right" price will be the most important service the investment banker will provide. Moreover, providing a fair deal to the marketplace in the IPO will improve the success of secondary offerings later on. Use of the proceeds: The most common use is for working capital needs and/or debt retirement. Using the proceeds for potential acquisitions is also a viable use but may be better left to secondary offerings. In any event, the use of the proceeds is an important part of the offering prospectus. Selling shareholders: Admittedly, one of the primary reasons for going public is to provide liquidity for the company's stock, especially for the company's founders who may hold a significant number of shares. In addition, venture capitalists that have provided funds for the company in the past may have an equity position that they would eventually like to "cash out." In general, however, doing so at the time of the IPO is not a good idea, as the market can view it as "selling out." It can create a question in the marketplace as to whether the management team is there for the long haul. On the positive side, this prevents too many shares from hitting the market in a short period of time, a phenomenon that can overly depress the share price. It does mean, however, that you may be only a "paper" millionaire at first. If you are seriously interested in doing an IPO in the near future, you need to begin by dealing with the issues listed above. The summer issue of the Graziadio Business Report will provide additional information on the costs involved and the pros and cons of being a public company. As a quick overview, however, you can anticipate that approximately 7% of the proceeds raised will go the various parties involved in the IPO process. In addition, there will be about $750,000 to $1 million of other fees and expenses. For a $50 million offering, it will cost your company about $4.5 million, for a $100 million offering, about $8 million. While this is a lot of money, if the various players do their job correctly, it will be money well spent, as it will allow your company to grow and expand in ways not possible before.

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The year 1999 was the year of the initial public offering, or IPO. There was a near record in terms of the number of IPOs, but even more impressive was the amount of capital raised. More than 45% of IPOs were priced above the initial target price range filed with the SEC. Moreover, the average 30-day return after the IPO was an astonishing 97%. With returns like that, who wouldn't think of taking their company public? In fact, the biggest gainer during 1999, Va Linux Systems, increased 697% on the first day of trading and ended the first 30 days with an overall 167% gain.

Incredibly, though, if you have not yet taken your firm public, you may not have missed the boat. Although it remains to be seen what effect the recent volatility in the market will have, so far during 2000 the pace is even higher. Through the first quarter of 2000 there were 140 IPOs, whereas during the same period in 1999 there had only been 71. Furthermore, the average IPO size, in terms of dollars raised, is increasing. In 1996, it was $60 million; in 1999, $130 million; and so far in 2000, it has increased to about $225 million. Whether it will continue at this pace is anyone's guess, but this may well be as good a time as there will be to go public.

Whether you are thinking of an IPO in the very near future or a bit further down the road, however, there are some important points to consider. The goal of this article is to provide critical information to assist you in determining whether the time is right for your company to go public. This includes summarizing the benefits as well as indicating the costs that you should anticipate.

Is the Time Right?

In terms of the number of IPOs, 1996 was the historical "high water mark." There were 758 IPOs in 1996 that raised approximately $45.5 billion, or an average of $60 million per firm. There was a steady decline for the next two years, as shown in Figure 1 below, with the average raised per firm declining all the way down to $10 million in 1998. Then came the explosive growth of 1999, both in terms of the number of firms going public and the amount raised. Additionally, the 30-day post-IPO performance took off from a low of 14% in 1997 to the 97% registered in 1999 (see Figure 2). Although 2000 is still young, through March that return increased again to an unbelievable average of 144%.

Figure 1

Figure 2

As you might suspect, technology stocks were the major driver of these returns, as 78% of IPOs in 1999 were technology related. As shown in Figure 3, Internet and software and communications companies comprised 66% of all IPO deals. The early statistics for 2000 indicate that the percentages are similar. When the 30-day returns are partitioned into the same industry segments, Figure 4 confirms that the large overall returns in 1999 are due primarily to those same two groups, although the communications sector has the higher returns. While the 40% returns for consumer and financial sectors are large by historical standards, they pale in comparison to the current returns in the other sectors. As one last indicator that the time may be right to go public, in one subset of technology stocks, business-to-business (or B2B), the 30-day returns for year 2000 IPOs averaged 184%!

Figure 3

Figure 4

Obviously, not every deal generates returns like these. But if your company is in any of the "hot" segments, you should be aware that returns like these cannot continue indefinitely. To decide if this is the time for you to try to realize these potential returns, you need to understand what is involved in the process of going public. The following section will provide an overview of that process, indicate the approximate cost, and list some of the downsides of being a public company.

On the Road to an IPO

From an overall perspective, there are three general steps in the IPO process: 1) resolving issues in planning for an IPO.2) going through the procedural process of actually doing an IPO, and 3) doing the "roadshow." Technically, the roadshow is part of step 2, but it is such a major element and time consuming process that it will be treated separately. The remainder of this installment will provide details about step one. Steps two and three will be covered in the summer issue of the Graziadio Business Report.

Planning issues: Before initiating the actual IPO process, you need to spend quality time thinking about and resolving the following issues. The answers to many of these questions are important because they will be incorporated into the Registration Statement that is filed with the SEC and made available to potential investors of the stock:
Size and timing of the offering: To provide sufficient compensation to the various parties involved in taking your company public, the proceeds should be at least $50 million. If management determines that it cannot reasonably justify need for that minimum amount, then venture capital may be a better alternative.
Selection of the team: In addition to company personnel, the team includes the underwriters, attorneys and outside accountants. The primary goal is to not only hire professionals that understand IPOs, but who also understand your industry. The underwriters are the most important player because they will be finding the initial investors and providing price stabilization for about 30 days after the offering. It would be wise to solicit presentations from several investment banks, from small to large. The attorneys' main role is to make sure that the legal documents conform to legal standards, and there are many choices of reputable firms that can be recommended by the underwriters. The auditors want to make sure that the information provided to potential investors is as accurate as possible. The "Big 5" firms (Ernst and Young, Arthur Andersen, PriceWaterhouseCoopers, Deloitte and Touche and KPMG Peat Marwick) control about 90% of the IPO market, so choosing one of these firms will help provide the needed credibility.
"Make-over" to a public company and positioning: The informational demands on a publicly held company are significant. After consulting with the potential members of the team, it may be recommended that you alter or change the company name, streamline the product offerings and/or refine the market focus to be able to better communicate the essence of the company to the public marketplace and maximize its value.
Management team: The pre-IPO planning process is a good time to evaluate the skills and capabilities of top management in a firm. Anyone currently at his or her maximum potential may not be able to help lead the firm to higher levels of achievement that shareholders will expect. Current owners and/or the Board may need to identify existing employees with these skills or hire a qualified outsider. Especially if the founding management is still in place, this may be difficult. In any event, the management team must be in place and functioning smoothly well prior to the IPO to assure potential investors that the leadership of the company is on solid ground. (The management team and the Board will also be described in the offering prospectus.)
Board of Directors: SEC regulations require that at least two members of the company's Audit Committee (or Board, if there is no separate Audit Committee) be independent outsiders in order to provide assurance of objective top-level leadership of the firm. In other words, the company can no longer be simply and solely family run. One potential cost to being a public company is that, while you may start as Chairman of the Board and Chief Executive Officer, unsatisfactory performance can result in your being removed from one or both positions.
Market/industry/sector conditions: Due to the lead times involved in going public, it may not be possible to hit the exact right time in terms of maximum funds raised. The company's investment banker can be helpful here in identifying trends. On the positive side, while the current bull market is very volatile, most analysts see few signs that it is really over, so a delay of a month or two may be inconsequential. If, however, there are serious downturns in the market during the IPO process, management should be ready and willing to postpone the offering.
Valuation expectations: The recent trend has been to select a conservative price range for the offering prospectus, test the waters, have the final offering price 20% - 30% higher, and then have the post-IPO price really "pop" to add additional visibility and excitement about the firm. In other words, having an IPO price too low is far better than having one too high. Next to helping the company actually market its stock, assisting in setting the "right" price will be the most important service the investment banker will provide. Moreover, providing a fair deal to the marketplace in the IPO will improve the success of secondary offerings later on.
Use of the proceeds: The most common use is for working capital needs and/or debt retirement. Using the proceeds for potential acquisitions is also a viable use but may be better left to secondary offerings. In any event, the use of the proceeds is an important part of the offering prospectus.
Selling shareholders: Admittedly, one of the primary reasons for going public is to provide liquidity for the company's stock, especially for the company's founders who may hold a significant number of shares. In addition, venture capitalists that have provided funds for the company in the past may have an equity position that they would eventually like to "cash out." In general, however, doing so at the time of the IPO is not a good idea, as the market can view it as "selling out." It can create a question in the marketplace as to whether the management team is there for the long haul. On the positive side, this prevents too many shares from hitting the market in a short period of time, a phenomenon that can overly depress the share price. It does mean, however, that you may be only a "paper" millionaire at first.

If you are seriously interested in doing an IPO in the near future, you need to begin by dealing with the issues listed above. The summer issue of the Graziadio Business Report will provide additional information on the costs involved and the pros and cons of being a public company. As a quick overview, however, you can anticipate that approximately 7% of the proceeds raised will go the various parties involved in the IPO process. In addition, there will be about $750,000 to $1 million of other fees and expenses. For a $50 million offering, it will cost your company about $4.5 million, for a $100 million offering, about $8 million. While this is a lot of money, if the various players do their job correctly, it will be money well spent, as it will allow your company to grow and expand in ways not possible before.

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