Public Enemy? How to go public and not get screwed

The E*Trade ads remind us: Someone's going to win theLottery. Just not you.

So what's your option? Well, did you hear about the start-up(eBay) that went public last year at $18, and despite 1998 netincome of only $2.4 million, saw its share price soar 535 percentwithin weeks and its market capitalization eclipse $21 billion?

Sounds like a typical success story in the high-flyingsecurities market, but it's not. In reality, eBay'sexperience is an aberration. Despite the popularity of and the hypeabout initial public offerings (IPOs), most small companies do notgo public, and many that do end up paying a price--financial andotherwise.

An IPO, in which a privately owned company raises capital byselling shares of the business to the general public for the firsttime, is a complex, expensive and risk-laden process that'sgenerally limited to rapidly growing, successful businesses(Internet-mania notwithstanding). Effective for attractinginterest-free expansion capital, the act of going public alsoimparts such benefits as stature, increased business and easierdebt financing.

Then there's the dark side of public ownership. Your companymust reveal sensitive information that will be available tocompetitors. Shareholders dilute your equity ownership. Theinclusion of outside directors on the board could jeopardize yourcontrol, perhaps inviting hostile takeover bids. Your stock becomessubject to market vagaries, and a plunge in price may discourageemployees, customers and suppliers, or even trigger lawsuits.

If you're willing to accept all that, are you also ready tocope with the administrative and legal demands of public ownership?Can you afford $50,000 to $500,000 for a process that may collapseat any point? Do you have the time (six to nine months) to devoteto a stressful, often frustrating, undertaking? Are you willing tojustify your actions to thousands of new investors? Maybe moretelling: Are you ready to relinquish sole ownership of yourcreation?

Is it for you?

"I tell many clients not to go public," says MikeLarrenaga, a partner in the Global Technology Industry Group atPricewaterhouseCoopers LLP. "You've got too many newissues to deal with when you're publicly held. As a privatecompany, you answer to no one, there's no salary cap, and noone's looking over your shoulder." The IPO specialistcautions against going public as a temporary fix. "Ifyou're not heavily indebted and growth is satisfactory,consider borrowing to meet immediate financial needs. Don't usea long-term solution [an IPO] for a short-term problem. Deciding ifan IPO is the way to go is one of the most difficult decisions anentrepreneur makes."

"[Deciding if] you're a suitable candidate for goingpublic ranks with such major decisions as choosing yourcareer," agrees Drew Field, a securities attorney and CPA whofounded and operates Drew Field/Direct Public Offerings in SanFrancisco. Field defines "a suitable candidate" as acompany people want to be part of that has a realistic chance tomake money for its investors.

"Among Business Start-Ups' readers are those with onlyan idea for a business and a need for money to implement theirideas," Field surmises. "Clearly, they are not candidatesfor public offerings." The author of Direct Public Offerings:The New Method for Taking Your Company Public (Sourcebooks, $19.95,800-727-8866) suggests a business first must have at least twoyears of profitable operations and audited financials. "Butthere are exceptions. A great [start-up] concept with the rightpeople might do a successful public offering if it were compellingand had a head start protected by patents, licensing or anadvantageous market position."

In December 1997, exactly two years after launching USWeb Corp.,27-year-old Joe Firmage successfully took his Internet companypublic, raising $150 million. Firmage, who recently co-founded anew company, Intend Change, which provides start-ups withconsulting and fund-raising services, advises start-ups to"prepare to go public as early as possible, but take yourinvestment banker's advice on timing the market." Beforebeginning the process, Firmage adds, "make certain yourfinances are in order, and don't exaggerate the proposal beyondyour ability to deliver."

Go Direct

Were you thinking of something less than $40 million? Big WallStreet firms won't listen, and midsized brokers have setminimums of about $25 million, according to Casey Alexander, seniorvice president and special situations analyst at GilfordSecurities, a nationwide underwriting firm based in New York City.Gilford focuses on deals of $8 million to $25 million, screeningcarefully for growth potential and to ensure the capital raisedwill be used for growth.

Those needing less capital should seek out regional brokers orconsider a direct public offering (DPO). That's what JenniferBarclay did in 1995, when her Blue Fish Clothing Inc. needed $2.5million for expansion. "Sales were growing 30 percent a year,and we needed to open more stores, computerize our systems andenhance our management staff," Barclay recalls. "Bankswouldn't provide the funds, and venture capital firms wanted ahuge percentage of the company." At the time, Blue Fish--whichdesigns, manufactures, wholesales, retails and mail-ordersartisan-produced women's wear--had three retail locations andsales of $9.7 million. In the course of her money hunt, Barclay,then 29, learned about DPOs--selling securities directly to large"affinity groups," such as employees or customers. Her9-year-old company had a mailing list of more than 30,000 women."Here was a loyal group I knew would support us," shesays. With help from a securities attorney, she arranged for a DPOand promoted the offering via hang tags, mailings, clothing,advertising, road shows and phone calls. The effort raised $4million.

But DPOs do have downsides: the expense factor and the lack ofaftermarket support (since there is no underwriter to help)."Our 1.1 million shares are traded on a small exchange[Chicago Stock Exchange: BLF]," Barclay adds. "It wasincumbent on us to market our shares after the public offering. Youmust be in the public eye, keep in contact with analysts and haveenough shares to generate interest."

Barclay advises, "Research the cost of going public--bothduring and after the offering--and know that being public isexpensive. Each year it costs us about $150,000 to comply withnecessary accounting, documentation and filings. A DPO is not aneasy solution. Get private equity financing if you can beforelooking for venture capital. Or just slow your growth instead ofundergoing an expensive public offering when your company is toosmall."

"Going public is the last thing you should do," saysTom Stewart-Gordon, publisher and editor of The SCOR Report(http://www.scor-report.com) inDallas, which provides small-business owners, lawyers andaccountants with news on small corporate offering securities lawsand how they are used to raise money. "An equity offeringprovides money you won't have to repay," Stewart-Gordonsays, "but you'll have to change the way you do business:You can't deal with Cousin Morty anymore" or do anythingthat might look even vaguely fishy to investors.

But if you need funds (most small businesses do), and youcan't enlist the support of a banker, a venture capitalist oran angel (most small businesses can't), the Small CompanyOffering Registration (SCOR) Form may make it easier--and lessexpensive--to raise capital. SCOR falls under Regulation D, Rule504 of the Securities Act of 1933, which governs all securities inthe United States. In essence, Reg D says equity offers of $1million or less are too small to concern the Securities andExchange Commission (SEC), so SEC registration isn't required,though you still must register your offer in each state in whichshares will be sold.

"It's basically designed to give the [averageentrepreneur] access to venture capital opportunities and givesmall companies a way to raise money from friends andneighbors," Stewart-Gordon explains. "It's usually alocal entrepreneurial undertaking that works best if you have alarge affinity group. If nobody knows your company or your product,chances are no one will buy the stock."

However, "only 30 percent of [SCOR offerings] sell,"Stewart-Gordon says. On the other hand, "only 40 percent ofcompanies with [sales] under $2.5 million ever successfully raisecapital from any sources, so 30 percent is not out of line."Stewart-Gordon estimates more than 750 companies have used the SCORForm for a public offering.

Hit the net

Using the Internet--as opposed to an investment bank--isn'tusually considered an effective way to find investor leads forIPOs. Despite that, Andrew Klein, 38, became one of the first totackle an IPO on the Net. In 1995, he raised $1.6 million for hisSpring Street Brewing Co., primarily by appealing to qualifiedpotential investors online.

"We raised capital because we were first and got lots ofmedia attention," Klein says. "Since then, most companiesthat have gone online and tried what we did have failed." Sotwo years later, the New York City entrepreneur launched WitCapital Group Inc. to help companies arrange IPOs. Since then, theonline investment bank and brokerage firm has helped take more than80 companies public. Last June, Wit Capital raised $78 million inits own IPO underwritten by Bear, Stearns & Co. Inc.

IPO Candidates

Between June 1998 and June 1999, more than 350 companies wentpublic, the most successful of which were high-tech, high-profileand high-growth businesses. "Success goes to those with veryhigh growth potential and a competitive edge that providesassurance they can achieve the growth," maintains KathyDurham, former vice president of Bank of America and now anAbout.com guide to the financial services industry (http://financeservices.about.com).But most businesses, she adds, "simply do not have the storythat will generate a large enough volume of investorinterest."

"Local retailers or service businesses should not evenconsider going public," Durham contends, "nor should anybusiness that is not widely known." Who should?"Businesses in a new or rapidly expanding industry such ase-commerce, Internet or Internet-related; other technologybusinesses such as biotech; and those with strong track records andcredible plans for major expansion."

But "industries go in and out of favor," argues CarolMuratore, a former Wall Street analyst with Morgan Stanley, now aconsultant to companies on the IPO track. More important than whatindustry or business you're in, Muratore holds, "is thatthere must be the expectation of growth and earnings."

Muratore, founder of Green Tree Research (http://www.greentreeresearch.com)in Santa Fe, New Mexico, notes that when a company goes public"it is creating a riskier security, so there should be ananticipated return in the form of stock appreciation and/ordividends to compensate investors for the risk. That's whatwill attract investors to buy the company's security instead ofT-bills or a less-risky stock."

Risky Business

"The biggest risk to entrepreneurs is being unprepared tobe public once they've gone public," contends Muratore.She stresses that an IPO "is the beginning, not theculmination, of wealth creation. Successful public companies haveclear strategies that are in tune with the dynamics of theirmarketplace--competent management, concrete operating plans, andthe focus and discipline to meet or exceed investors'expectations."

Once ownership passes to the public, there exists the risk ofhostile corporate takeover. One of the best deterrents to that issuccess. "A high valuation will deter those looking to stealthe company," says Muratore, whose firm offers consultingsupport in strategy, finance and communications to high-growthcompanies planning IPOs or dealing with the challenges of beingpublicly traded.

To protect your own future with your company after going public,retain a majority interest in the business and/or revise yourcorporate bylaws to discourage takeover attempts. However, realizethat sometimes, it's in the best interests of the company forthe founder to step aside. As companies grow and transform, theyface new and different challenges best confronted by those withbroader experience and qualifications. Furthermore, once you gopublic--that is, once you accept other people's money inexchange for their ownership in your company--you have a fiduciaryresponsibility to run the company for their benefit, not yours.

Wherever you are as the process begins, recognize that the actof going public means you must work through a maze of business,financial and governmental demands that require substantial timeand money. You may need to revamp much of your business andfinancial organization, and you'll be forced to contend withcomplex and overwhelming disclosure requirements that must bestrictly adhered to at great expense. Nevertheless, with a viableoperation, capable advisors, and the conviction to propel yourcompany into a growing and prosperous future, going public can bethe fast track to reaching your goals.

Go for it

If you're ready to proceed with an IPO, the followingfactors are key to success:

1. Your team. Your first step is to find an attorneyand an accounting firm that are familiar with IPOs and that haveexperience with the SEC. Get recommendations from trustedassociates.

Then consider underwriters. You want a strong, honest firm thathas the best analyst in your industry. Your attorney and accountingfirm can recommend reputable brokers with successful IPO trackrecords. Interview several brokers and meet the analysts. Warning:Brokers will pitch you at these meetings. Don't be pressuredinto any deals until you confer with your attorney, accountant andother advisors. The underwriter will also be evaluating yourcompany--the strength of your management team and your experience,expertise, business knowledge and growth strategy.

Once you've selected a securities firm, it becomes part ofyour team. From that point on, almost everything leading to the IPOwill be done by, or under the direction of, the underwriter: forms,documentation, filings, printing the prospectus and registrationstatement, the road show and the pricing of your stock.

2. Is the price right? Entrepreneurs often feel theunderwriter is underpricing IPO shares. They're right. Sharesmust be offered at discounts to compete with proven peers in themarketplace. If prices are too high, you may not meet your capitalneeds; the price drops in the aftermarket; initial buyers suffer aloss; confidence in the underwriter, your company and its sharessuffers. Ideally, the offering price is negotiated among threeparties: the entrepreneur, the underwriter and the institutionalcommunity. IPOs that rely on retail sales alone usually aren'tsuccessful, so feedback and involvement from the institutionalcommunity are essential.

3. Timing. Entrepreneurs scramble to take theircompanies public at the perfect time. In reality, you won't beable to choose the perfect time. It takes 90 to 120 days afterfiling before the offering reaches the marketplace. In today'sfinancial markets, that's a lifetime in terms of themarket's potential receptiveness to a given deal.

4. Time. Be prepared to spend an inordinate amountof time going public. One person overseeing the process must devoteabout half time for six months; a person responsible for accountingwill devote about one-fourth of his or her time for three or fourmonths; the CEO will have to devote considerable time, energy andattention to the project--no matter how much work has beendelegated. Warning: During the IPO process, many CEOs get so caughtup in the deal that their businesses falter. If you take your eyeoff the business, financials may suffer in the first quarter out ofthe box. That means your stock suffers, you don't meet marketexpectations, and you lose credibility, which is difficult toregain.

5. Aftermarket efforts. Assuming you've doneeverything right to successfully complete your IPO, you then mustcommit to the business of selling shares. It's like adding amajor product line. To make your shares attractive to the public,you must constantly strive to improve profits and keep the publicinformed of all developments. An investor relations firm can helphere; so, too, can an underwriter committed to your companylong-term and not just for the IPO.

6. Takeover trouble. Beware: Introduction of outsidedirectors may jeopardize your control and open the door to hostiletakeover bids and tender offers. To preclude such threats, retain amajority interest in the business and control over its future sale,and have your attorney amend your corporate bylaws withshark-repellent clauses.

Smart Move

Read it

For additional information and insight on going public:

• Going Public, a book that details the basics of goingpublic, is available free from Nasdaq; call(202) 496-2600.

• Direct Public Offerings: The New Method for Taking YourCompany Public (Sourcebooks, $19.95, 800-727-8866) is authorDrew Field's definitive guide to an alternative method fortaking your company public. Field also provides online insight forthose considering DPOs at http://www.dfdpo.com

• Hoover's Online (http://www.hoovers.com) includesinsight on IPOs as well as up-to-the-minute listings of new,postponed and withdrawn IPOs.

• Yahoo! (http://biz.yahoo.com/ipo) describesupcoming new public offerings and reports company details andbackground info on recent IPOs.

• IPO Monitor (http://www.ipomonitor.com) providesa comprehensive set of services, such as e-mail alerts tosubscribers on daily registration filings, pricings and performanceof new offerings. The easy-to-use Web site allows you to capture awide range of IPO and company information when searching by name,industry, underwriter, location, date or offering size.

• The National Association of Securities Dealers (http://www.nasdaq.com) provides accessto IPO information as well as requirements for trading your stockon the Nasdaq market.

The IPO Alternative

A direct public offering may be a viable and less-expensivemeans of taking your company public. Drew Field/Direct PublicOfferings in San Francisco provides the following criteria forcompanies considering a DPO:

• The business would excite prospective investors, making themwant to share in its future.

• There is a history of profitable operations under thecompany's present management.

• The company and management meet standards of honesty, socialresponsibility and competency.

• The business can be understood by people who may have noexperience investing in shares.

• The company has natural affinity groups with discretionary cashto risk for long-term gain.

• Those affinity groups will recognize the company's name andbe willing to consider its share offering materials.

• Affinity group names, addresses, telephone numbers and somedemographics are in the company's database.

• A company employee is able to spend half time for six months asproject manager, directed by the CEO.

• The company has, or can obtain, audited financial statementsfor at least the past two fiscal years.

(For an in-depth look at screening tips and additional DPOinformation, visit http://www.dfdpo.com)

Ready, Set, IPO?

Answering these questions will help you determine if it's agood idea for you to take your company public:

• Are you emotionally ready to share ownership of yourbusiness?

• Are your associates, attorney and accountant in favor of anIPO?

• Are you prepared for the intense legal and accounting scrutinyrequired of public companies?

• How much of the company's resources are you willing tocommit to the offering process and aftermarket AC demands?

• Do you or your business have relationships with other companiesor family enterprises?

• Will you be comfortable having your salary reportedpublicly?

• Will you accept board of directors' dictates governing yourcompensation?

• Can you endure a board that may oppose you?

• Will your business appeal to investors?

• Can the substance of your business be readily explained topotential investors?

• Do you foresee rising share prices over the next year ortwo?

• How much ownership will you relinquish?

• How much money do you intend to raise?

• How will the proceeds be used?

• Do you have a five-year plan for the business?

• When will you need additional capital?

• Would a less-costly strategy achieve the same ends?

• Can you accept the possibility of eventually being forcedout?

What it will cost you

Going public is a major undertaking that involves substantialcosts. Ultimately, expenses will vary depending on the size of youroffering, the number of states in which you register, the caliberof professional support you enlist and more. The following figuresare estimates only.

Brokerage fees: Commissions charged by underwritingbrokers are almost always 13 percent for IPOs less than $10 millionand 7 percent for those over that amount. Beyond this, securitiesfirms are usually awarded other benefits, such as warrants topurchase shares in the future.

Professional services: On average, you should budgetbetween $100,000 and $250,000 for legal and accounting fees.

Registration fees are as follows:

States: Fees for registering securities under Blue SkyLaws range from $25 to $10,000 per state.

SEC: The Securities and Exchange Commission assesses afiling fee of 1/36th of 1 percent of the aggregate offering.Beginning in 2000, the filing fee drops to 1/38th of 1 percent.

NASD: The National Association of Securities Dealers'fee is $500 plus 1/100th of 1 percent of gross proceeds beingregistered.

Nasdaq: $34,525 for offerings less than 1 million shares,graduating to a maximum of $95,000 for offerings exceeding 124million shares.

American Stock Exchange (AMEX): $10,000 for fewer than 1million shares, ranging up to $50,000 for more than 125 millionshares.

New York Stock Exchange (NYSE): $51,550 for fewer than 1million shares, ranging up to $504,600 for more than 125 millionshares.

Documents: Be prepared to spend $50,000 to $200,000 onprinting and mailing documents, including the prospectus,registration, statement and underwriting agreements.

Post-IPO: As a publicly held company, you will incur ahost of annual expenses upwards of $50,000 a year. This includesauditing, legal services, quarterly and annual reports, proxyreports, miscellaneous filings, transfer agents, public relations,investor relations, printing and mailing.

Example of a selected IPO: Earthlink

Offering size $26 million

Total shares 2 million

SEC registration fee $10,454.55

NASD filing fee $3,950

Nasdaq National Market listing fee $43,000

Printing $175,000

Legal services $175,000

Accounting $170,000

Transfer agent $3,000

Miscellaneous $19,595

Total cost $600,000

They did it: you can too

Between June 1998 and June 1999, more than 350 IPOs raised inexcess of $40 billion, as reported by IPO Monitor.com (http://www.ipomonitor.com), anonline service that provides subscribers with up-to-date IPOinformation. Among those offerings:

Balance Bar Co. , Nutritional snacks, June 2,1998, $10.5 million

Career Builder Inc., Online recruiters, May 12, 1999,$57.2 million

Cheap Tickets Inc., Discount travel, March 19, 1999,$52.5 million

Drkoop.com Inc., Online health information, June 8, 1999,$84.4 million

Hometown Auto Retailers Inc., Car dealerships, July 29,1998, $16.2 million

Priceline.com Inc., E-commerce, March 29, 1999, $160million

Omega Protein CP, Fish products, oils, April 2, 1998,$137 million

Wit Capital Group Inc., Investment banker, broker, June3, 1999, $78 million

Zany Brainy, Specialty retail chain, June 3, 1999, $38.1million

Contact Sources

Blue Fish Clothing Inc., (908) 996-3844

Gilford Securities, 850 Third Ave., 14th Fl., New York,NY 10022, (212) 940-9276

PricewaterhouseCoopers LLP, (714) 435-8600, mike.larrenaga@us.pwcglobal.com

USWeb Corp., (408) 987-3200

Wit Capital Group Inc., 826 Broadway, 7th Fl., New York,NY 10003, http://www.witcapital.com