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Going Public

Ready for a whirlwind ride? Take the ultimate funding trip by going public. This guide will help you prepare.
December 7, 2005

What It Is: An initial public offering (IPO) is the sale of equity in a company, generally in the form of shares of common stock, through an investment banking firm. These shares subsequently trade on a recognized stock market. For smaller, emerging companies, the stock market will probably be the Nasdaq SmallCap market or the Nasdaq National Market System.

Appropriate for: Startup to established companies. Startup companies must demonstrate the potential to develop into profitable enterprises that will deliver significant annual increases in sales and earnings. Established companies must also demonstrate significant future growth potential. In either case, minimum earnings growth potential is 20 percent per year, and the company should be able to achieve a valuation (total shares outstanding times their price) of at least $100 million to be truly successful as a publicly held corporation.

Best Use: Financing the expansion of manufacturing or service capacity or marketing activities that have immediate impact on earnings; also, providing a company with increasing sales, as a layer of working capital to fund growing inventory (if there is any) or accounts receivable. IPO funds can be used to finance research and development, but stock prices tend to decline during prolonged periods of product development, which in turn generates a new set of challenges for founders or senior management.

Cost: IPOs are perhaps the most expensive way to finance a company. Not only will an IPO cost a significant chunk of the company's equity--no less than 25 percent and perhaps a great deal more--but fees and expenses can climb to as much as 25 percent of the deal. For a $5 million offering, that's $1.25 million.

Ease of Acquisition: Unreasonably difficult. Going public is one of the most challenging transactions. During robust economic periods, about 750 to 1,000 companies go public each year in offerings underwritten by investment-banking firms. Many more try but fail during the process.

Range of Funds Typically Available: $5 million or greater

First Steps

What are the strategic reasons a company should consider an initial public offering?

In addition to strategic considerations, being a public corporation often confers the following benefits:

Going public makes you rich--at least on paper. And make no mistake, none of the lawyers, accountants or investment bankers involved in the process gets the least bit squeamish about your desire for riches. After all, your success means their success. For entrepreneurs who want to go public, their first, most important, task is to find an investment banking firm that will underwrite the offering. Once that task has been done, with a little luck, a strong market and a lot of determination, everything else will fall into place.

Finding Your Investment Banker

To find the right investment banker, you must conduct some research. Specifically, you must discern which firms in the past two years have consistently done initial public offerings similar in size and scope to the one that fit your needs.

There are three good sources of historical information on initial public offerings:

Investment Dealer's Digest is expensive but can be reviewed at any corporate or public library that subscribes. The SEC New Registrations Report, also expensive, can be found in libraries as well. The website www.ipocentral.comis free.

Whichever source you use, your research should identify 50 to 75 investment-banking firms that appear to underwrite IPOs similar in size to the deal you want--namely, $5 million $15 million. Of these firms, the following algorithm will indicate which are the best candidates to pursue and which might be better left alone.

However, the investment banking firm that does just one IPO a year is probably pretty picky about its deals. Look at the thumbnail financials of the companies the firm underwrote. If the following characteristics are true:

1. all their underwritings are for profitable companies;
2. all their underwritings are for companies in one industry;
3. all their underwritings are for companies with substantial revenue, and you possess none of these characteristics, this probably isn't a match.

Getting Introductions

Even though your research may have helped you identify the underwriters you believe are the best candidates to take you public, that doesn't mean they want to hear from you. According to John Lane, an investment banker in Westport, Connecticut, with more than 20 years of experience in investment banking, "Most people in our business will not even look at a business plan that has not been in some way personally referred to them."

Lane's comment underscores a tough reality for entrepreneurs. If you aren't plugged into the financial community, your row is a tougher one to hoe.

You can be plugged in to a referral by making a connection between yourself and the underwriter. You can do this by hiring the following professionals:

Selling the Underwriter

When you meet with an underwriter, it's likely that you will be expected to make a formal presentation. However, in addition to presenting your company, there are other important points to keep in mind to ensure that your first discussion with the investment banker is not your last.

Common Deal Breakers

Most IPOs die on the drawing board, which is the period of time between when an investment banker issues a letter of intent and the day the offering is filed with the SEC. Here are the top 10 reasons offerings die on the drawing board.

1. The investment banker tells the company founders they must lock up their shares and agree not to sell them for a period of 24 to 36 months. The founders refuse to do this.
2. The company's founders hide legal or financial problems that the underwriter eventually finds out about.
3. The company's financial reporting is aggressive. If upon further analysis of the company's financial statements it turns out that if it had more conservative accounting policies, the company would actually report a loss, the underwriter will shut things down.
4. The company dickers too much on the fees the investment banker is charging.
5. The company's founders and the underwriter are too far apart on what they think the company is worth and what public investors will pay for it.
6. A lack of salesmanship o the part of the company's owners or founders proves they are unable to excite anyone about the deal. 7. The company is in an industry that "falls out of bed" with Wall Street. Remember conglomerates?
8. Some wrinkle about the company or the offering prevents it from getting clearance in a state that contains several or all of the investment banker's customers.
9. The company cannot afford the $250,000 it will cost to put a preliminary prospectus on the Street.
10. The deal structuring drags on for a long period of time and sales and earnings begin to fall. Unfortunately, the decline may be directly attributable to the amount of time senior management spent cooped up with accountants, lawyers and investment bankers.

The Timetable

Here is the typical timetable for an IPO from when an entrepreneur commits to the process to when he collects the big check at the end of the closing table.

Week 1: Conduct organizational meeting.

Week 5: Distribute SEC registration statement; hold additional drafting sessions.

Week 6: Distribute second draft of registration statement; hold additional drafting session.

Week 7: Distribute third draft of registration statement; hold additional drafting session.

Week 8: File registration statement with the SEC; begin preparations of road-show presentations; begin getting clearances in states where the offering is to be sold.

Week 12: Get comments from the SEC on registration statement.

Week 13: File first amendment to registration statement with the SEC; addressing comments.

Week 14: Prepare and distribute preliminary prospectus; commence road-show meetings.

Week 15: SEC declares offering effective; company and underwriter agree on final price. Prepare, file and distribute final prospectus.

Week 16: Close and deliver offering proceeds.

Excerpted from Financing Your Small Business. To read more about IPOs and 17 other financing options, buy this guide today.