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Initial Public Offerings

What Is an Initial Public Offering?

An initial public offering (IPO) is the first non-private sale of securities by an issuer or a person controlling the issuer to members of the public. Generally, any offering that is not exempt under the private offering exemption of the Securities Act of 1933 (Regulation D) is a public offering.

What Steps Are Required For an Initial Public Offering?

There are several steps that must be taken before a company can make a public offering. The following is a basic layout of what must be done:

  • Determining the value of the company – Usually, a company must be valued at between $50 million to $100 million after a public offering to attract an institutional following. Evaluating comparable companies is an effective way of determining your own company's value.
  • Deciding on the amount of the offering -The offering must be worth at least $15 million and total more than 2 million shares in order to attract institutional buyers.
  • Selecting managing underwriters – Selecting the appropriate managing underwriters is a vital and difficult task. Issuers should look for managers that are both reputable and large, yet have the time and commitment to treat the client with personalized attention.
  • Figuring out the timeline to market – It typically takes between six to ten weeks to prepare the registration statement and prospectus included in an IPO filing, plus an additional five to seven weeks to complete the c review process. Issuers must coordinate this schedule with their company's financial reporting cycles, since financial statements cannot be more than 135 days old at the effective date of the IPO.
  • Enacting a quiet period – The company should cease all press and other public activities once a decision has been reached to begin the IPO process. Doing so will minimize the risk of activities such as insider trading and other forms of securities fraud.

What Are The Benefits of an Initial Public Offering (IPO)?

There are several benefits for a business to "go public" with an initial public offering:

  • Cash – A successful IPO can generate a very large sum of money. Of the 278 IPOs offered between 2001 and 2003, the average deal size was $316 million and the median size was $106 million.
  • Liquidity for employees – This is particularly important for technology and life sciences companies, where providing incentives to the most highly qualified prospective employees is critical. In the wake of the Enron scandal and other examples of executive overpay through stock options, this may be undergoing significant change.  Consult an attorney about using an IPO for this purpose.
  • Liquidity for investors – Investors are always looking for a way to receive a higher and faster return on their investments, and an IPO is one good method of achieving that. Timing and restrictions on selling are very important here to avoid a speculation bubble.
  • Creation of a currency for acquisitions – Stocks may be as valuable as cash for acquiring other businesses. Stocks are also a good way of minimizing tax liability in a way that cash cannot.
  • Access to the public market – A company that has completed its initial public offering may return to the public market for future financings in follow-on offerings. Using an IPO establishes a relationship with underwriters, financial analysts, and investors.
  • Enhancement of the company's stature, perceived stability, and competitive position – One effect of an IPO is the credibility of a company's fame, staying power, and place in the competitive market. This often helps to get good results with hesitant buyers and lenders. The media is also much more likely to provide publicity to a public company than a private one.
  • Enhancement of the company's market value – A successful IPO exposes the company to a broad base of investors, some of whom may have been unaware of the company or unsuited to purchase its stock. This exposure usually increases the demand for the company's stock, increasing its market value.

What Are the Disadvantages of an Initial Public Offering?

Some of the burdens a business can experience with an initial public offering include:

  • Distraction of management from operation of the company – The offering process usually takes three to five months and includes tasks that simply must be performed by management, such as the selection of investment bankers, presentations, and drafting sessions.
  • Restrictions on publicity and marketing – The Securities and Exchange Commission (SEC) forces companies to have a "cooling off" period in which the company is not allowed to publicize its impending IPO, which could lead to overhype. During this time, marketing activities must be done with a constant eye on securities law.
  • Compliance with SEC disclosure and reporting requirements and the Sarbanes-Oxley Act of 2002 – Once a company goes public, it is subjected to a whole host of strict and intrusive disclosure laws. Corporate governance, accounting, and in-house counsel will almost certainly need to be beefed up and modified. 
  • Reduced flexibility in corporate affairs – Again, extensive new laws have been placed that force a company to disclose much more information and to allow stockholders to vote on many more issues. These reduce the flexibility of management to conduct business as it sees fit and often slows the company's corporate activities to nearly a standstill. 
  • Exposure to class action securities litigation – Public companies face increased exposure to lawsuits for securities fraud, particularly when a major announcement of bad news is given. Class action suits may take years to resolve and may result in the loss of millions of dollars.
  • Loss of control – Upper management and the founders of the company will lose a great deal of control as more issues are voted on by stockholders. This may interfere greatly with an existing business plan.
  • Vulnerability to a hostile takeover – If insiders do not hold a significant percentage of the company, this vulnerability is especially real.
  • Expense – In addition to taking several months, the cost of going public has also risen dramatically. In 2003, the average cost of an IPO including legal, accounting, printing, transferring, and underwriting fees was more than $3.5 million. This creates a much riskier environment in the term after the IPO when employees may sell their stock or the company may disappoint investors.

Is My Company Ready For an Initial Public Offering (IPO)?

Not all companies are ready for an initial public offering (IPO), and "going public" too soon can be disasterous to some businesses.  All of the following should be considered before an initial public offering:

  • Does the company have the "right stuff"? – This generally includes such things as a disciplined and experienced management team, strong financial control, a good financial outlook, a large target market, a sustainable business model, and a good competitive market position.
  • Does the company meet the criteria set by bankers and investors? – To be underwritten by a top tier investment banking firm, the typical IPO candidate will be profitable or at least show a clear path to profitability, have quarterly revenues of $15 to $20 million, show signs of strong market growth, have a post-IPO valuation of at least $200 million, and a proposed offering size of at least $40 million.  However, these rules will differ wildly depending on your industry.  If your company has an unusually innovative product or an exceptional management team, bankers and investors will probably ignore a deficiency in the other criteria.
  • Would the company's offering benefit from additional milestones? – This is basically a question of timing.  Sometimes it is better to get more "seasoning" or show greater profit growth to give investors more confidence in your company. 
  • Is the company prepared to operate under the obligations of going public? – This is a question of confidence and whether the management team knows what it is doing.  The management team must be able to deal with the burdens of completing registration with the SEC, presenting a viable business model, restricting publicity during the offering process, meeting SEC disclosure requirements, meeting stock exchange listing requirements, and relinquishing control to public investors while still maintaining profit growth.
  • Is an IPO the best route to achieving the company's objectives? – This requires a great deal of research and soul-searching.  Other methods of raising capital and prestige are always available and are sometimes faster, cheaper, and much less burdensome.  Presenting an initial public offering is a very long and complicated process and also contains continuing burdens, so don't do it if you are looking for some quick cash or five minutes of media attention.

When Is The Best Time For My IPO?

The timing of the initial public offering is probably the most difficult question to answer.  Using an IPO when the market is "hot" often gives a higher valuation and is very competitive with other similar companies, but results can falter in subsequent quarters when the market cools off, creating frustration in management and disappointment for stockholders.  This is especially dangerous if your company is not completely ready for such a venture.  

Market windows can also be seasonal.  Although it is simply a rule of thumb, generally late August is a poor time to bring a new IPO to the market because many investors are enjoying their last weeks of summer with their families before the school year begins for children.  The Thanksgiving and Christmas holidays are also traditionally difficult times to bring new offerings.  

Should I Seek Advice From an Attorney Familiar with IPO's?

Bringing an initial public offering to market is a very complicated process that could make or break your company.  It is highly profitable but also very risky. It is also an extremely complicated process that requires good timing and a knowledge of the road ahead. Consulting a business attorney, especially one with investment or financial experience, can save your company an invaluable amount of time and energy. 

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