Last issue, Professor Davis looked at the recent explosion of initial public offerings (IPOs) and pointed out things to be aware before taking your firm public (Thinking of Doing an IPO?). Now, he looks further at the process of going public and offers more pros and cons. Editor
In spite of the significant market gyrations during the last quarter, the market for Initial Public Offerings remains strong. While the number of IPO pricings in the second quarter of 2000 declined about 22 percent from the number in the first quarter, the total value of those that were priced increased from $28.4 billion to $32.8 billion. As long as the fundamentals of reasonable interest rates, a stable but growing economy, and expanding technology remain in place, the market for IPOs should continue on its record-setting pace, albeit with a few bumps along the way.
The first half of this article was about the planning process that occurs prior to the formal decision to do an IPO. If your company is serious about going public in the near future, you will want to review that process and the nine critical issues with which it deals:
- Size and Timing of the Offering
- Selection of the Team – Insiders and Outsiders
- “Make-over” to a Public Company and Positioning
- Composition and Capabilities of the Management Team
- Composition of the Board of Directors
- Market/Industry/Sector Conditions
- Valuation Expectations for the IPO
- Use of the Proceeds
- Sale of shares by Company Officers
This article will complete the overview by laying out the formal IPO procedural process and discussing the purpose and requirements for the “roadshow,” a grueling two to three week marathon of presentations to investor groups about your company. The approximate cost will also be discussed, as well as the pros and cons of being a public company. Finally, a list of useful web sites will be provided should you want to do additional research on your own.
Due to the tremendous number of IPOs in recent years, the actual procedures to be followed in going public are fairly standardized. They usually take approximately 16-19 weeks, although it may be possible to shorten the time down to 13-14 weeks. In essence, there are four major phases that include the following major steps:
Preparing for the IPO – Weeks 1-5:
- A “Kick-off” Organizational Meeting of the IPO Team is held. This all-day meeting involves setting the principal terms of the offering (including the size and price), determining the time and responsibility schedules; and a presentation by upper management on the status and future of the firm. (See the sidebar below for more details on this part of the planning process.)
- The registration statement is drafted. This is the formal legal document which is filed with the SEC and the specific stock exchange on which the stock will trade. This statement will go through many revisions prior to completion and will likely have to be amended after review by the SEC.
- Audited quarterly financial statements are prepared. Three years of audited financial data are required, with at least one year of quarterly data. In addition, “stub period” financial statements are required for the current period.
Filing/Review – Weeks 6-13
- After the IPO team finalizes the registration statement and prepares the filing package, the registration statement is filed electronically with the SEC and physically with the exchange on which the stock will be listed.
- Four to five weeks after filing, comments from the SEC will be received. These must be addressed and an amended registration statement filed. There will likely be additional comments by the SEC, resulting in another amended registration statement.
- A preliminary prospectus is printed for distribution during the roadshow presentations.
The Road Show – Weeks 14-16
- This is the all-important “marketing the deal” series of presentations to domestic and international analysts and investor groups. The purpose is to identify and differentiate your company. It serves as a forum to display the managerial talent that got your company to this point and demonstrate its ability to carry the company into the future.
- The success of the roadshow will be evident in the “book,” the compilation of share orders by investors and fund managers.
- A dynamic and memorable 20-30 minute presentation is prepared. This is critical, both in terms of presenters and methodology (See the second sidebar below for details.)
Pricing/Closing – Weeks 17-19
- The SEC finally declares the registration statement to be effective.
- The final offering price is determined and the lead underwriter determines final share allocations.
- Trading begins; a press release announces the offering; and a tombstone advertisement is published.
- The company receives the net proceeds.
Keys to a Successful IPO
Obviously, having a successful company to offer to the public marketplace is essential. Beyond that, it is important to recognize this in not a place for do-it-yourselfers. While the roadshow represents the formal coming out of the firm, its success will partially depend on the groups selected for the audience, and this, in turn, depends upon the lead investment banker/underwriter in the IPO. Choosing the right underwriter is probably second in importance to choosing the right time to go public. The essential elements to look for in the ideal lead underwriter are as follows:
- The underwriter is focused on your industry. The IPO marketplace is a crowded marketplace and the significant sums you are spending for professional advice to go public need to be targeted to a firm with real expertise in your industry. Partial evidence of appropriate expertise would be having an analyst devoted to your industry.
- The market relies heavily on analyst projections and recommendations. Specifically, the underwriting firm’s analyst in your industry must:
- Have the capacity to cover your company with sufficient attention.
- Understand your company, customers, and competition.
- Indicate sincere commitment to covering your company.
- Due to the importance of a successful roadshow, the underwriter must have the ability and contacts to identify the right investor groups for your presentation and get them committed to attend. References from previous IPO successes are essential.
- There must be sufficient evidence of being able to build a quality “book” of potential orders for your stock.
- There should be a history regarding the ability to identify the right offer price and size.
- Finally, but rarely understood by many non-public companies, there must be significant aftermarket support in terms of maintaining and supporting trading in the stock, providing subsequent research reports on the company, and continuing institutional exposure to the company.
What Does All of This Cost?
To justify the costs involved, $50 million is about the absolute minimum offering. The direct costs for a $50 million offering total about $5 million. The largest cost is the industry standard 7% of the gross proceeds, or $3.5 million paid to the lead and secondary underwriters involved in selling your stock. Legal and accounting costs are about $450,000, printing about $150,000, and various miscellaneous expenses another $150,000.
Ten percent of the gross proceeds, or $5 million, is admittedly a lot of money. Moreover, it doesn’t include the cost of management time and any disruption of normal business. While proper incentives are important to the success of the deal, it is your money. There will be a constant tension between relying on the advice of the professionals you are hiring versus aggressively influencing the decisions being made. Asking lots of questions, suggesting alternatives, and generally conveying the impression that you have to be convinced of the necessity of every expenditure will go a long way in making sure your company gets its money’s worth.
Some Pros and Cons of Going Public
There are some major advantages to being a public company. However, it must be acknowledged that there are also some serious drawbacks and risks to be considered. Probably the biggest benefit of being a public company is that it will be easier to go back to the public markets to raise more cash – a “follow-on offering.” Typically, about one-third of all IPO issuers return to the public market within five years and raise about three times as much capital as they did in the IPO. Internet related companies have been returning much faster, on average within 9-10 months of their IPO.
Second, it is easier for individuals to “cash out,” either partially or completely, since there is a ready buyer’s market. Many entrepreneurs have worked hard and long to get their companies to this stage, possibly at little or no salary. While a complete cash out would be unusual, and likely would impact the stock price negatively, a modest cash out can be viewed positively by the market and still provide cash to the owners so they can enjoy some of the fruits of their hard work.
Third, stock options for officers and employees can be a valuable compensation tool, both for retaining valuable employees and as an additional enticement for prospective employees. No doubt you are aware of the numerous employee millionaires at Microsoft, even down to the secretarial level!
Finally, being public makes it easier for other companies to notice and evaluate the firm for possible merger and acquisition, should that be your goal. This outcome could complete a “double whammy” of profit – first, when your firm went public and, second, when you are offered a sizable premium over current market price to merge with another company.
The potential of being acquired, however, is a double-edged sword that leads into the disadvantages of being a public company. Since your stock is now publicly traded, if the company has one or more poor quarters, the stock price may become quite depressed, making it easier and cheaper for someone to take over the company. Moreover, if outsiders gain sufficient control, you could be out of a job.
Second, public companies must continuously file various reports with the SEC and the exchange they list on. Quarterly financial results must be provided to all shareholders and other interested parties. Some type of investor relations department must be created and staffed to handle investor inquiries. In essence, your company now lives in a glass house, making it easier for observers to see your successes – and your failures.
Third, and this one is fuzzy at best, it is no longer “your” company. Not only do you have to answer to shareholders, there is now a subtle but distinct pressure to “satisfy the market.” This is not the market for your product but the market for your numbers, i.e., your quarterly earnings. The pressure will be on to “make the numbers,” or the projected earnings per share, every quarter. As a result, long range planning – and risk taking – must be approached very carefully, especially if the payoff for a potential project is years away. Gone are the days when you could pursue an idea without real regard to the bottom line. Now that bottom line may very well run your life.
Is it worth it? Obviously for many companies the answer is “yes,” and, the answer may be “yes” for your firm. The goals in this two-part series were to inform you of the process and make you aware of the potential benefits and payoffs. Of course, there are risks and trade-offs. Armed with this overview, along with appropriate professional advice, you should be much more able to make an educated decision.
Useful Websites for further information
http://www.iporesources.org (no longer accessible)- a site maintained by Professor Ivo Welch
http://www.hoovers.com – a site with lots of statistics about IPO activity
– another site with lots of statistics about IPO activity
For Further Information…
The Organizational Meeting is at least a one full day of activities that includes:
1. Introduction of the Working Group: This group is comprised of high level company management, company counsel, outside auditors, the lead or managing underwriters, the underwriters’ counsel, the printer, and any consultants hired by the company to act as an independent advisors to the company as the IPO process progresses and issues or questions arise. Regarding the need for consultants, Dr. Ivo Welch, a professor of finance who maintains an IPO resource web page, writes,
“It is astonishing how rarely independent advisors on relationships with IPO experts are retained by entrepreneurs, and how frequently independent advisors on relationships with IPO experts are retained by lawyers in lawsuits between firms and their former advisors later on.”
Procedurally, all issues affecting the upcoming IPO will be handled or delegated by this group. Due to the compressed time frame of the IPO process and the busy schedules of all parties involved, the finalized list of working group members, including addresses, phone, pager, fax numbers, and email addresses will be prepared and distributed. Finally, all parties are made aware of the confidential nature of the discussions.
2. Discussions about the Offering: This is lengthy and detailed. It covers:
- The size ($50 million should be the minimum) and composition of the offering. (It is recommended that existing shareholders not offer their shares during the IPO.)
- The target price range and whether there is a need for a pre-IPO stock split to move the projected value of the company into the target price range.
- Fees and expenses to be incurred. (These will be discussed subsequently.)
- Use of the proceeds. (Typically they will be used for working capital and/or debt payoff.)
- Distribution of the shares. (Typically, this will be 80% domestic and 20% international.)
- Agreement to a “lock-up” period. (Generally all significant shareholders agree to hold their shares for 180 days after the IPO.)
- Registration rights of “early holders,” especially venture capitalists who may want to cash out as part of the IPO or soon thereafter.
- Directed share programs, whereby designated individuals are allocated shares during the IPO and are able to buy them at the IPO price. (This last item has been growing significantly in usage during the boisterous IPO market. Prior to 1998, most were limited to close friends and family members. Many firms now utilize these programs to reward critical employees, suppliers and customer, in addition to family members. Used effectively, these programs can add significantly to the success and excitement about the company.)
3. Time and Responsibility Schedules: These weekly schedules will include major corporate events, scheduling conflicts of working group members, and a week-by-week listing of responsibilities and meeting assignments.
Other activities during the Planning Period include:
4. Due Diligence Activities:
- Company management will make presentations to the group regarding the status and future of the company.
- The underwriters will provide a list of issues/questions to be resolved.
- Site visits will need to be set up.
- The auditors must be interviewed.
- Interviews with major landlords and vendors must be arranged to insure that there are no unknown issues or pending lawsuits.
- The directors and officers will need to complete questionnaires about their ownership interests and involvement in the company, including related-party transactions. (This is an ongoing process involving continuous business, financial and legal review of the company and its environment.)
5. Business Matters: The company management team and Board of Directors will be presented and justified. During the pre-planning process, there may have been changes made to either or both groups to strengthen or broaden them so that a frank discussion of vision, skills and experience will help provide assurance to all members of the working group about their qualifications. Additionally, the group will be made aware of any significant operational matters (major new products to be introduced, impending strikes, etc.).
6. Accounting Matters: As previously mentioned, three years of audited data are required, with a minimum of one year providing quarterly results. In addition, stub period financial statements for the current period are required. Although the audit may take some time, the working group can be made aware of potential areas where the company is not following GAAP and thus where changes will need to be made and reflected in the financial statements. As the actual date of the IPO nears, the auditors will provide a comfort letter to the underwriters indicating that the financial position of the firm is as indicated in the financial statements and that there are no underlying unresolved accounting or financial issues.
7. Legal Matters: Two issues are of primary importance here:
- First, the status of pending or threatened litigation. No one wants to invest in a firm about to sued to the point of bankruptcy! As a result, any “at fault” cases should be discussed and attempts made to settle them before the IPO. Other actions, to the extent possible, should be resolved or liability minimized prior to the IPO.
- Second, there must be full disclosure of all material related-party transactions in the registration statement. Other legal issues needing attention will be formal establishment of a shareholders’ meeting, selection of a transfer agent/registrar, and identification of decisions that will need Board authorization.
8. Publicity: It has been said that you can’t “over advertise.” While true in most situations, prior to the IPO the firm should be very careful not to overstate its case, especially regarding the effectiveness, uniqueness, etc., of its service or products. The SEC will review the materials containing such claims. This is especially true for the company’s web site, since it will be easily accessible. That warning aside, the company should develop plans to make its presence known as much as possible — in industry trade journals, information releases, conferences, and finally, meeting with security analysts. Overall, the buzzword phrase in publicity is “controlled, appropriate, and carefully worded” dissemination of favorable company information.
9. Printing Issues: A printer experienced in printing registration statements and prospectuses will be needed, as these are very specialized documents. Any artwork, including appropriate lead times to develop and revise, needs to be coordinated carefully. These documents will be the primary “picture” that potential investors and the SEC will have about your company. They should be prepared as professionally as possible.
At the end of Phase One, about six weeks will have zoomed by, for in addition to all the working group meetings and related assignments, there is still a company to run – and run well. Now, it’s time to deal with the SEC.
The roadshow is the capstone activity in the IPO process. If you are a born marketer, you’ll love this phase. If not, get ready to be stretched and questioned, even possibly belittled, like never before. In a very real sense, you’re the new kid on the block and, therefore, an unknown quantity. You will be making formal 20-30 minute presentations to both domestic and international institutional analysts and investors, justifying why they should either recommend your firm or actually invest in it. You’ll be dealing with professionals who can quickly spot weaknesses or risks. It will be crucial for you to be aware of such potential problems beforehand and have a ready and well-thought-out response. Investors don’t like surprises. Whether there are computer problems during your presentation or serious questions regarding the future potential of the company, you must stay in charge, stay cool and exude confidence and passion about your company.
Regarding the passion issue, I have heard big-time investors state that “if the company management is not excited about its company and products or services, why should I be?” As a result, there is one primary preparation guideline for a successful roadshow: practice, practice and more practice – as a team. Just as you likely “live the company,” for a two – three week period, you need to “live the road show.” Your presentation must be well-documented and give a, high impact impression that if these investors don’t invest in your company, they will have missed a great investment. To insure a polished presentation, it will be wise to hire a presentation consultant to help flesh out the important details and develop a memorable portrait of your firm. Part of the polishing will be practicing the presentation, as a team, over and over until each member is fully comfortable both with his or her material and with possible questions or criticisms that may be raised.
The presentation should be high impact, graphical, and tastefully animated. It should:
Present the Theme: What excites you about your company?
- Business and Industry Overview
- Key Strategies
- Differentiating Factors
In practical terms, the goal in the first few minutes is to “set the hook and work the reel.”
Avoid the “Great Company, Limited Market” definition. Few will invest if the market is too small to justify the risk.
- Document the total market size.
- Justify the addressable market for your company and product line.
- Discuss market and segment dynamics – what is unique about your industry.
- Provide key and/or benchmark clients to convey acceptance in the marketplace.
Present Current Strategy and Show Flexibility/Adaptability to Ensure Growth.
- Think out three to five years.
- Show current and future ability to execute.
Share appropriate anecdotes, major contracts, significant competitive wins, key milestones achieved.
Demonstrate knowledge of the competitive environment:
- Specific names, products and knowledge of competitor plans.
- Barriers to entry and exit.
- Differentiating factors to foster victory.
- Realistic assessment of prospects to hold expectations in check.
Address the risks – give investors confidence that all is not “pie-in-the-sky” dreaming.
Finally, educate the listener on the financials, both historical and projected:
- Return on Capital
- Gross Margin
- Research & Development goals
- Spending on Selling, General and Administrative costs
- Operating Margins
- NI and EPS