increasing number of small and medium-sized companies are choosing to
create initial public offerings (IPOs) as a way to survive in today's
competitive marketplace. When carefully planned and executed, they can
often provide an effective way to raise needed capital. However,
nothing comes easy and a lot of advanced planning is necessary for a
successful IPO in today's market.
"IPOs enable business owners to diversify their
investments without selling or losing control of their
companies," said Fred D. Lipman, of the Philadelphia law firm of
Blank, Rome, Comisky & McCauley and author of Going Public:
Everything You Need to Know to successfully turn a Private Enterprise
into a Publicly Traded Company. "Any privately-held
business with growth potential can go public."
If that last statement is true, then there must be a
lot of companies with growth potential since over 15 companies per
week went public in 1995, compared to just 15 per quarter in 1980.
According to Lipman, over 150 IPOs were executed by companies with
gross annual earnings of less than $10 million. "We had a company
with no revenue and no earnings that raised $15 million," he
said, "but they initially had $5 million in preferred
While that example may put stars in the eyes of
business owners strapped for funds, the reality of IPOs is a bit more
disconcerting. "With so many companies going public, it's hard to
get investors' attention," said Patrick Hurley, general partner
with Howard, Lawson & Co. and editor of The IPO Reporter until it
was sold to Dow Jones. "The trick is for a company to distinguish
itself from the pack."
"Growing a business is like a food chain,"
said George M. Jenkins, a venture capitalist with the P/A Fund in
Radnor who has invested in a number of companies that have later gone
public. "At first entrepreneurs take their ideas and seek out
business angels to get the capital to get started. Then later they
need greater amounts of money to keep going and venture capitalists,
like myself, invest in their companies. Finally, they're
self-sustaining and need capital to expand. That's where IPOs come
Raising Capital from an IPO is First and
Foremostf a company's valuation in the
public market is high, it often can seek capital in both the public
and private sectors. IPOs are a way for business owners to achieve
liquidity--a way to sell stock. They also help to motivate and attract
key employees and provide another form of payment for acquisitions,
trading stock instead of cash. "The market determines which
companies should go public," said Howard Ross, consultant with
Arthur Andersen & Co., who works with emerging companies that have
later gone public. "There's no boilerplate answer."
What is the rationale behind why a company asks the
public for money. For a large company, critical mass is enough of a
reason. The IPO provides liquidity and currency for acquisition. But
for a small company, access to capital is the single most important
"A small company needing $10 million or more
will get a better price publicly than privately," said Hurley.
"A public company sells common stock, while private investors
require convertible preferred stock or redeemable convertible
"If a company receives $5 million in venture
capital, it puts that money into preferred stock," he added.
"Private investors holding preferred stock always expect that the
business will either go public or that it will be sold. The structure
of venture capital investment provides the return of the investor's
capital first, as well as participation in company operations. These
investors must seek a way out, either from the sale of the company or
through a public offering."
A company that executes a public offering is in much
more control of its destiny and offers more value. However, this
control comes at a high price. It costs $200,000-300,000 per year to
go public--with no benefits. That's a high price to pay for what may
amount to private investing.
"There are always reasons why people hold
stock," Hurley said. "They may want to sell it, but it's the
business owner's job to create the demand. After going public, the
owner now finds he's in two businesses--his original one and the
security business--trying to sell stock in company."
A business owner has to have a good reason for
taking his company public. He has to be able to access large amounts
of capital to accomplish his long-term business strategy. Otherwise,
it's not worth the cost. If his public costs are too high, then he
might as well take his company back private. He has to make a decision
which is best in the long-term.
"The most difficult challenge in going public
is getting the attention of institutional investors," added
Hurley. "IPOs are traditionally traded at 10-15 percent below
what a company's stock is expected to trade at. This is intended to
create an early reward for those who buy unseasoned stock."
Most companies going public immediately go to the
NASDAQ national market list, the only one published in newspapers
across the country. Otherwise, investors won't know a company is
An institution's minimum liquidity requirement is
100,000 shares of trading per week per company. Some refuse to buy
shares unless an analyst follows a company and publicly researches it.
It's the job of the analyst to attract investors to do business with
the firm. In fact, institutions see the analyst as someone who can
ferret out returns over time, acting as the company's front man.
What Does an Emerging Company Need
to Do to Initiate an IPO?
A company has to show evidence that it's on a growth curve. The more
growth potential in its industry sector, the greater potential for
success of the company's IPO. It must show a minimum 15-20 percent
annual return. "The less a company's track record, the greater
its growth potential," said Lipman. "I believe a company's
size is unimportant. Its earnings must give credibility to its growth
projections. If it's projecting 20 percent growth, better have a
record to back it up."
Lipman also recommends that business owners
establish management credibility by making a chief financial officer
part of their management team. The company should also adopt a stock
option plan, as well as a thorough business plan. It should also have
prestigious names on its board of directors and be incorporated as a
Sub-Chapter S corporation.
"But one of the most important things is for a
company to have a track record," said Lipman. "Its owner
should follow the marketplace, comparing private and public capital
sources and decide which is right for his company before preparing to
George Jenkins believes a company should create a
minimum of a $10 million offering, before which a company would have
an equity of $20 million, thus giving the public one third ownership.
"Purchases of IPOs are 90 percent
institutional," said Hurley. "These investors need to feel
they have liquidity in stock, as well as in subsequent public
offerings. The company needs to put the money received from its IPO to
work, to show the investing public that their money to being put to
Research the Market
A business owner also has to look at other companies in his category
in the IPO market. If there are a lot, he may not be able to sell his
stock due to competition, If there are no other companies in his
category, he has a chance.
If a company has the growth required and has done
its homework as to marketing its IPO, how does it position itself to
initiate one? A company planning to go public should develop an
impressive management and professional team. Its owner should grow his
business with an eye to the public marketplace. He should obtain
audited or auditable financial statements. He should also establish
two classes of stock or other anti-takeover defenses and create
insider bail-out opportunities, select his own independent board of
directors, and take advantage of IPO windows, fads and IPOs of similar
companies. But most importantly, he should clean up his act.
"Early on, a business owner should get to know
Wall Street underwriters," said Jenkins. He recommends working
with a venture capitalist firm like the P/A Fund. "We pick the
right management teams and scan the marketplace for operating
companies as if they had already gone public. We look at their boards
of directors, reporting systems, general operating procedures--and
"We add value to strategic companies by helping
them think through diversification and expansion," he added.
"We help them think these things through and help them determine
when the timing is right to go public."
Venture capitalists like Jenkins know underwriters.
They're involved with hundreds of companies, and by being involved
with them, a company is given referenceability in the marketplace.
How Long Does this Whole Process
It can take from four weeks to six months to convince underwriters on
Wall Street to help a company go public. Once an underwriter is
selected, it's basically a predictable mechanical process, taking from
nine to twelve weeks. This involves preparing the prospectus, filing
with the FCC, and advertising.
"Some companies in the early stages cultivate
underwriters to cut down on the time required to initiate an IPO,"
said Ross. But most important: Owners should have a complete
management team, know their five-year strategy, and surround
themselves with advisors who know the pitfalls."