Burnt Offerings? It's understandable to be bedazzled by the riches you see in other companies' IPOs. But before you follow their lead, make sure your company is cut out for going public.

Oh, what might have been...were it not for an initial publicoffering. Strange as this may sound, in many cases, it's true.You hear it all the time: "Going public is an incredible drainon management's time," but such a warning often getspassed off as just another dollop of prudent yet obvious advicethat, like all other prudent advice, is forgotten in the quest forIPO riches. Yet the fact remains: When entrepreneurs are forced totake their eyes off business operations to deal with theintricacies of an IPO, it can have disastrous effects for allinvolved.

Art Beroff, a principal of Beroff Associates in Howard Beach,New York, helps companies raise capital and go public.

Public Peril

Consider the tale of Microleague Multimedia Inc., once a hotshotlittle company that traded on Nasdaq's SmallCap market, now ahas-been that's left behind a trail of broken dreams, stiltedcareers and shareholder losses.

The company had a promising beginning; it was seemingly pulledout of thin air through a series of deals orchestrated by NeilSwartz, an able, engaging entrepreneur. By 1996, Swartz had built acompany with $5 million in sales and four business units thatdeveloped multimedia software, primarily for the sports andentertainment markets. This momentum enabled Swartz to put togethera $5 million IPO in May of 1996.

The bloom started to come off the rose just three months later,however. In its first earnings release as a public company,Microleague announced that its forthcoming title, SportsIllustrated Presents Microleague Baseball 6.0, upon which theIPO had been largely predicated, would be delayed. The product wasdelayed again in the fall. Meanwhile, Swartz was spending more andmore time soothing ruffled investors and trying to put togetherdeals that would help the company make up for lost time. By 1998,Microleague was headed toward Chapter 11.

"There's no doubt about it: I left the operations toothers and spent a lot of my time with investors," saysSwartz. "If I had concentrated my efforts on continuing tobuild the business, it might be a much different storytoday."

Swartz, who is now a principal with MCG Partners Inc., amerchant banking firm in Boca Raton, Florida, is drawing on hisexperience to help other companies avoid the pitfalls he ran intoin the public equity markets. According to Swartz, "Somecompanies shouldn't attempt an IPO in the first place becausethey don't have the ingredients to succeed as a publicentity." So the question remains: Should your company be on anIPO track, or will you make the most money by staying private? Hereare some acid-test questions to help you find out:

• Are you building a company that can run without you?Large companies hire financial professionals to structure deals andwork with investors. In smaller companies, it's generally theCEO who rides herd on these duties. That's fine--unless therest of the organization can't function without yourleadership, input, vision, direction or whatever warm fuzzy youwant to put on it. In retrospect, muses Swartz, this was hiscompany's downfall. "I did deals, and I left the businessto people who may not have had enough management skills andexperience to pull off what I was selling to investors," hesays.

  This doesn't mean that a nuts-and-bolts micromanagingentrepreneur can't take his or her company public. It simplymeans that if this is your personality type, you need to hire a CFOwho has operated public companies and been through the IPO processbefore.

• Can you get to a market capitalization of $100 millionwithin three years of going public? Remember, the so-calledmarket capitalization of a public company is the total number ofshares outstanding--in other words, those shares held by the publicand the founders, multiplied by the market price of the shares. Forexample, if a company has 10 million shares outstanding and theprice is $10 per share, the market capitalization of the company isthen $100 million. Why is this benchmark so important? Becauseit's at this level that a company begins to attract awide enough following among brokers and institutional investors toensure a vibrant liquid market for its shares. It's not thatsmaller IPOs aren't viable; it's just that they must growrather quickly to succeed as a public entity. For instance,Swartz's Microleague started life as a public company with amarket capitalization of approximately $22 million. This would havebeen fine if, within a short period of time, the company haddeveloped the kind of sales and earnings to command a $100 millionvaluation.

  Your financial projections will show whether you can reach thislevel in the required period of time. Keep in mind that the valueof a public company is generally a multiple of what it earns andthat industries tend to have different multiples. Find out theaverage multiple for your industry by looking at the averageprice-earnings ratios for your publicly traded peer companies. Takethis figure, and apply it to the earnings you project for threeyears after your company goes public. If it's not close to $100million and shows no signs of getting there, your company isn'ta good candidate for going public.

• Are you building a company with high gross and operatingmargins? The gross margin is your sales less the cost of yoursales (as a percentage of sales), and the operating margin is yourgross income less your selling, general and administrative expenses(as a percentage of sales).

  Again, no rules are written in stone, but high margins areimportant because they keep companies out of the volume game. For acompany to reach critical mass in earnings with low margins, itmust generate enormous sales growth.

  To generate not only high sales volume but also growth in thatvolume, a company must meet two requirements. First, it must haveaccess to tremendous amounts of funding to promote and financesales. Second, it can't falter--missing on the top line canoften cause a disproportionate loss on the bottom line. And nothinghurts a public company more than unanticipated losses.

  If you want some hard and fast evidence that low-margincompanies should stay away from the public markets, check out theNovember 30, 1998, issue of Forbes magazine, which lists the500 largest private companies in the United States. Note how manyare supermarket companies, which are known for having razor-thinmargins of 3 percent or less. The point is, if being publicdoesn't appear to be viable to many of these giants--who haveannual revenues ranging from several hundred million to billions ofdollars--you've got to question whether your low-margin $2million business can make a serious go of things as a publiccompany.

• Can your business deliver double-digit sales and earningsgrowth year in, year out? This stipulation is more or lessimplicit in the requirement that a company reach a marketcapitalization of $100 million as soon as possible. After all, ifyou go public at considerably less than this level, you'll haveto grow fast to catch up.

  But there's another reason why high-octane growth is derigueur. The public equity markets will settle for nothingless. Remember, public companies compete with all other publiccompanies, plus thousands of mutual funds, for the attention andcapital of investors. So, in a world filled with Ciscos and Intels,to say nothing of a hot new breed of Internet stocks, what possiblereasons would investors have to bet on a virtually unknown companythat's growing at the speed of cold tar?

• Are you building a family business? Mixing familybusiness and public shareholders can work out just fine. After all,if the public owns two-thirds of the company and a manageablenumber of family members who work inside the business own the otherone-third, then their interests are aligned in a positivesymbiosis. However, while the family thinks generation togeneration, public investors think quarter to quarter. If thebusiness hits a few bumps, the shareholders, with theirshorter-term views, will probably clamor for immediate change.Often, this change doesn't include the next generation of thefamily.

  Again, it's not that you can't have a successful familybusiness that's also public. But be cautioned: If youabsolutely, positively must turn over the reins to the nextgeneration, don't go public because the business may very wellnot be there for your successors if you do.

• Can the business be built inexpensively? Many publiccompanies go public for the express purpose of creating what'sknown as a pipeline to capital markets. The pipeline concept restson the theory that public companies can raise funds much moreeasily than private ones. For instance, once public, companies canraise additional money through a secondary offering or by sellingshares privately. All of this thinking is cogent if the companydelivers sales with the financing received during the firstgo-round, i.e. the IPO.

The sad fact is, except for biotechnology companies and, ofcourse, Internet companies--which break all the rules ofconventional finance--nobody wants to pump money into a companyonly to learn a year later that it needs still more to achieve thegoals it claimed it could reach with the first infusion ofmoney.

The Final Analysis

On the issue of whether to go public, Swartz says, "Thebest offense is a good defense." Without the right ingredientsto take your business public, it may not be worth the toll theaction will take on your company. Remember, riches still awaitthose who sell their businesses to larger corporations, and thelikelihood of executing such a transaction increases if thebusiness has been carefully nurtured by a hands-on entrepreneur whohasn't been distracted from producing strong sales and earningsgrowth.

David R. Evanson's newest book about raising capital iscalled Where to Go When the Bank Says No: Alternatives forFinancing Your Business(Bloomberg Press). Call (800)233-4830 forordering information. He is a principal of Financial CommunicationsAssociates in Ardmore, Pennsylvania.