Synchronize Your Watches

Investment Considerations

Is the window open? This is the most obvious, and least controllable, factor in a company's decision to attempt an IPO. The opportunities for IPOs are often discussed in terms of "windows"--the window is either open or shut. During the third and fourth quarters of 1998, when the Dow took its precipitous 1,700-point drop, the window was tightly shut. In 1976, there were just 16 IPOs completed. The window, if not shut, wasn't open more than a crack. At the dawning of the second half of 1999, the window was open, as the market was receptive, even eager for IPOs. So the first lesson about timing your IPO is to make your attempt when the window is open. But that's just for openers. Other factors that will enhance your chances of completing a successful IPO include:

  • Your industry is in favor. This is almost self-enforcing. That is, if your industry is not in favor, you'll have a hard time even getting an appointment with an investment banker to discuss an IPO, let alone pull one off. Presently, energy companies are out of favor. So are financial-services companies. So are aviation-services companies. If you run a business in any one of these sectors, it's not time for your IPO.

A slightly improved position is being in an industry that is not out of favor. Presently, application software companies, though not as in vogue as they were in the late 1980s and early 1990s, are at least considered palatable. Of course, the best position is to try an IPO when your industry is in favor. For instance, if you run an Internet company, the timing for your IPO couldn't be better.

For better or worse, Reflective defies any easy industry category, meaning it can't be hurt or helped by any such industry favor. The company will have to place more emphasis on other areas, such as underlying markets, management teams or financial performance.

  • You are about to turn the corner to profitability. Companies sometimes go public when they're posting losses. You hear about them, not because it's so common, but because it's so uncommon. But there is far less publicity surrounding the slow death the stocks of these companies face, as quarter after quarter of losses pile up and investors lose all interest. It's far better to go public and report ever-improving earnings than it is to go public and report ever-narrowing losses.

Krentcil says that since Reflective is not an Internet company, where the above rules do not apply, the level of profitability will play a vital role in the firm's IPO decision-making process. "We might be able to entice an underwriter into doing a deal now," he says, "but with the better earnings we're projecting, we think we can get a much higher valuation in our deal by waiting a little longer."

  • Your company has a layer of professional management in place. Going public is an incredible drain on a company's human resources. So if you're the in-house visionary who is also responsible for executing the strategy, monitoring that execution and tinkering with the strategy midstream--while selling all this to investors, keeping them updated, and feeling good about it--then your IPO is a 911 call waiting to happen.

At Reflective, Krentcil says he believes his team is in place. "Our board is complete, and we have the key marketing, legal, financial and sales positions filled."

The reason an incomplete management team spells disaster is that the growth an IPO is generally predicated upon can't occur when management takes its eye off the ball to keep investors happy. One software company went public in 1996 with a deal premised on getting the 1997 version of their sports entertainment software to market by the Christmas selling season. Senior management spent so much time executing the IPO that the product never made it to market. Today, the company doesn't even exist.

  • There is a logical set of buyers for your deal. This is difficult to explain but is nonetheless an important concept with respect to the timing of your IPO. Specifically, does the nature of your business make your deal appropriate for institutional or retail investors, and is it appropriately sized for the buyers? For example, most biotechnology deals today are bought exclusively by institutional investors. Why? Because they are far too complex for individual investors to understand.

This institutional orientation means, however, that deals must be in the neighborhood of $25 million with a market capitalization (total shares outstanding times price) of at least $100 million. Therefore, if you need to raise $5 million for a biotechnology company, your timing is probably off, and your company needs to be much bigger before you attempt an IPO. On the other hand, Internet deals can be purely retail, meaning that even as a start-up in search of, say, $7.5 million, your timing is on, and you can probably pull off a deal.

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This article was originally published in the November 1999 print edition of Entrepreneur with the headline: Synchronize Your Watches.

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