2.05 – Raising Money Through IPOs
The allure and myths surrounding the IPO (initial public offering) have grown with the massive IPOs of upstart dot-com companies that lacked profits. The excitement of seeing your stock on an exchange and the media attention can momentarily overshadow the hard work leading to this point and the ongoing effort to satisfy stockholders and analysts.
Many entrepreneurs dream of going public within a few years of starting their businesses, but the reality of launching a public company is far more complex. It’s crucial to do your homework—read and talk to people who have done it—before deciding on an IPO. Once you decide to proceed, you set a series of events in motion. Canceling an IPO at the last minute is costly and damaging.
An IPO is essentially a more complex version of a private offering. You file your intent to sell a portion of your company to the public with the Securities and Exchange Commission (SEC) and list your stock on an exchange. The proceeds from the IPO go to the company in a primary offering. If you sell shares later, those proceeds are called a secondary distribution.
Considering the Pros and Cons of Going Public
Many entrepreneurs go public because an IPO provides a significant source of interest-free capital for growth and expansion. After a successful initial offering, you can conduct additional offerings if you maintain a positive track record. Other advantages include:
- Increased Clout: Greater influence within the industry and financial community.
- Partnerships and Deals: Easier to form partnerships and negotiate favorable deals with suppliers, customers, and others.
- Employee Incentives: Ability to offer stock options to employees.
- Wealth Harvesting: Easier to sell shares or borrow against them to realize the wealth you’ve created.
However, becoming a public company also has several disadvantages:
- High Costs: The cost of an IPO can exceed $300,000, excluding the underwriter’s commission.
- Time-Consuming: The process can take most of your week for over six months.
- Public Scrutiny: All company activities become public information.
- Shareholder Accountability: You become primarily accountable to shareholders, sometimes over customers or employees.
- Loss of Control: You may lose controlling interest in your company.
- Stock Volatility: Your stock value can be affected by economic factors even if your company is performing well.
- Pressure for Short-Term Performance: Intense pressure to perform quarterly to satisfy shareholders and drive up stock prices.
- SEC Reporting Requirements: Extensive and time-consuming reporting obligations.
Deciding to Go for It
If you’ve weighed the advantages and disadvantages and still want to pursue an IPO, you need to understand the steps involved in the process.
Choosing the Underwriter
Your underwriter, typically an investment banker, will guide you through the IPO process and help sell your securities to institutional investors. Secure an introduction to a reputable investment banker through a mutual acquaintance and investigate their track record. Once chosen, the investment banker drafts a letter of intent outlining the terms and conditions of the agreement, including an estimated stock price range. If you’re unhappy with the final price, you can cancel the offering, though you’ll be responsible for some incurred costs.
Satisfying the SEC
You must file a registration statement with the SEC, known as a red herring, which outlines the potential risks of investing in the IPO. This prospectus is given to potential investors. After filing, you advertise the offering in the financial press through a tombstone ad. Your prospectus is valid for nine months after publication.
Decide on which stock exchange to list your company. The two best-known exchanges in the United States are the National Association of Securities Dealers Automated Quotation (Nasdaq) and the New York Stock Exchange (NYSE). The NYSE is the most challenging to qualify for and operates as an auction market, while Nasdaq is a floorless exchange trading through a system of broker-dealers.
Taking your Show on the Road
The road show, a two-week tour presenting your business to major institutional investors, is a critical part of the IPO process. The goal is to oversubscribe the offering so it can be sold quickly. Investors want to know why your company is a great investment opportunity, focusing on their return on investment.
Here are some tips for effective presentations:
- Tell a Great Story: Investors want to know why your company stands out. Highlight the benefits and return on investment.
- Founder’s Passion: The entrepreneur/CEO should tell the story, bringing passion and energy that can increase the business’s valuation.
- Honesty is Key: Don’t exaggerate. Address potential problems and explain how you plan to overcome them.
- Grab Attention: Start with a relatable problem and present your company as the solution.
Dealing with Failure
Even if you do everything right, an IPO can still fail. For instance, a Texas company developed a durable computer for tough environments but only raised $300,000 of the $1.5 million to $9.9 million goal, eventually filing for Chapter 7 bankruptcy. The total bill for the IPO was about $250,000, and the company received nothing.
Starting an IPO doesn’t guarantee success. Many entrepreneurs cancel their IPOs at the last minute due to insufficient capital raised during the roadshow.
By thoroughly understanding the IPO process and preparing for its challenges, you can make an informed decision about whether going public is the right move for your business.
