Initial public stock offering (IPO) is not so much an event as it is a process and it takes many months of planning and a whole cast of specialized characters to prepare a company to ‘go public’… Along the way all types of bad things can happen…
Initial Public Stock Offering (IPO) 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% and perhaps a great deal more–but fees and expenses can climb to as much as 25% of the deal.
For a $50 million offering, that’s $12.5 million. 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. Going public is one of the most challenging transactions.
There were 154 U.S. IPOs in 2010, Renaissance Capital says, up from 63 in 2009 and 31 in 2008. Many more companies tried but fail during the process. An IPO provides owners and founders an exit for selling their ownership holdings in the business. For entrepreneurs and others 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. However, 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 U.S. Securities and Exchange Commission (SEC). Here are the top 10 reasons ‘offerings’ die on the drawing board.
- 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.
- Company’s founders hide legal or financial problems that the underwriter eventually finds out about.
- Company’s financial reporting is aggressive. If upon further analysis it turns out that if it had more conservative accounting policies, the company would actually report a loss, the underwriter will shut things down.
- Company complains too much about the fees the investment banker is charging.
- 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.
- Lack of salesmanship on the part of the company’s owners or founders proves they are unable to excite anyone about the deal.
- Company is in an industry that “falls out of bed” with Wall Street.
- Basic issues about the company or the offering prevent it from getting clearance in a state that contains several or all of the investment banker’s customers.
- Company cannot afford the $250,000 it will cost to put a preliminary prospectus on the Street.
- Deal structuring drags on for a long period of time and company sales and earnings begin to fall.
In the article “The Ups And Downs of Initial Public Offerings” by Marc Davis writes: Many companies pursue IPOs as a means to increase the amount of available financing to the company and possibly generate millions for the owners in the process. The Upside of Going Public:
- Money to grow the business: With an infusion of cash derived from the sale of stock the company may grow its business without having to borrow from traditional sources, and will thus avoid paying the interest required to service debt.
- Money for shareholders and others: With more cash in the company coffers, additional compensation may be offered to stakeholders, founders and owners, partners, senior management and employees enrolled in stock ownership plans.
- Other benefits of going public: Once the company has gone public, additional equities may be easily sold to raise capital.
The Downside of Going Public:
- Once a company goes public, its finances and almost everything about it – including its business operations – is open to government and public scrutiny. Periodic audits are conducted; quarterly reports and annual reports are required. The company is subject to SEC oversight and regulations, including strict disclosure requirements. The company is subject to shareholder suits, whether warranted or not…
- Preparation for the IPO is expensive, complex and time consuming. Lawyers, investment bankers and accountants are required, and often outside consultants must be hired. As much as a year or more may be required to prepare for an IPO. During this period, business and market conditions can change radically, and it may not be a propitious time for an IPO, thus rendering the preparation work and expense ineffective.
- An IPO may look like a great means of making money but close-up, there are many flaws. However, these should not dissuade a company from going public, just keep in mind that an IPO is not a guaranteed money-maker for companies and/or shareholders.
In the article “Nine out of 10 European IPOs Fail” by Elizabeth Pfeuti writes: Nearly 90% of companies that have sought to list their shares in Europe this year have either pulled the deal or have subsequently seen the shares fall by more than the markets on which they floated. Thirteen of the 25 IPOs worth over $200 Million announced so far this year have been pulled, according to Financial News research based on Bloomberg data. Of the 12 that made it to market, only two were trading above their initial listing price when the markets closed. Global stock markets have tumbled since these companies listed. But the share prices of all but three of the market debutants have fallen faster than the indices they joined.
The head of equity capital markets at one large investment bank said: “Part of the problem is the slump in the broader market, over which we have no control, but the IPO process does need improving. There is clearly dissatisfaction with what’s being done. But now is not the time to point fingers.”
Among the 13 deals that have been withdrawn or delayed since January, three were potentially worth over $1Billion. The FTSE 100 has fallen 4.7% in the same period. Jonathan Ingram, portfolio manager in the European equity unit at JP Morgan Asset Management, said: “We looked at all the deals that were announced in Europe this year and there was a clear trend running through them, and that is a ‘wait and see attitude’…”
In the article “Chinese IPOs Fail to Live-Up to Hype” by Matt Krantz writes: Chinese IPOs are turning into Wall Street’s version of fireworks: They go up in a fantastic spectacle, then fizzle and fall to earth. Initial-public-offerings of Chinese companies have been all the rage in the U.S. this year, and are accounting for roughly a quarter of all the year’s deals. Investors have piled-in, pushing the value of most Chinese IPOs up on their first days of trading.
But Chinese IPOs are crashing almost as dramatically. Consider that the year’s 40 Chinese companies to go public in the U.S. are:
- Lagging the U.S. stock market: Chinese IPOs are up 8.1% on average from their first-day closing prices, say data from Renaissance Capital and Standard & Poor’s Capital IQ. That means Chinese IPOs are lagging the 12.9% gain by the Standard & Poor’s 500 and 18.1% for all IPOs.
- Posting losses more times than not: Nearly half the year’s Chinese IPOs, 22, are down from their first-day close, the price at which most individual investors would have had a chance to buy in. And 19 of 2010’s Chinese deals are below their actual IPO prices.
- Relying on a few success stories: Chinese IPOs’ performance is even worse if you look past the two that have been big winners, HiSoft, up 184%, and Camelot Information, up 130%. However, Chinese IPOs are down 2.6% on a median basis, which factors out the effect of extreme returns.
The fact Chinese IPOs are fading fast might come as a surprise. These deals have rocketed 16%, on average, their first trading day. Stories of fast economic growth in China have investors clamoring to get into China’s IPOs, says Donald Straszheim of ISI Group. “You’re seeing the money slosh around in the latest hot IPO market,” says John Fitzgibbon of ‘IPOscoop.com’.
But the realities of supply and demand are setting in fast once the first-day hype wears off and investors who pay attention to valuation step away, says Francis Gaskins of ‘IPOdesktop.com’. Sometimes it doesn’t take a full day for the hype to subside…
In the article “Brazil’s IPOs Fail to Impress” by Jonathan Wheatley writes: Brazil’s new IPO season has got off to less than a flying start, with three out of four offers going to market below the bottom end of their target price range. This year had been billed as a return to the heady days of 2007, when 64 companies went public, raising R$55.6 Billion.
But turmoil in Egypt, coming on top of rising concerns over how Brazil’s government will deal with rising inflation, have dampened investor enthusiasm. If you look at Brazil’s key fundamentals, they are all still in place. If issuers are more realistic about their price expectations there’s no need for delays.
“All the offers that I can see and that we are working on are not holding back. In some ways we’re in a more mature market. Investors are maybe not jumping over each other any more but actually running the numbers and making sure of what they’re trying to get.” Does that make this a buying opportunity? Companies must hope so. Six more IPOs are registered at the CVM, Brazil’s securities commission, and five secondary offers.
An IPO is part of a company’s financing strategy. A well-conceived and executed business plan will have specific goals for growth and revenue accompanied by financing needs and options to achieve each step of the path. The rule-of-thumb for an IPO ‘ready’ company include: substantial growth, near profitable, need for funding, good management, good story to tell, and right time in the market for your type of business.
Each industry has different criteria for growth and revenue in ‘going public’; therefore, it is important to research publicly traded companies of similar size in your industry to see there performance indicators (e.g., revenue, profit, market share, etc.) when they went public. One of the most important factors considered in deciding whether a company is ready to IPO (in addition to profitability) is growth rate.
The “ideal” is considered to be what bankers call “40/40”: 40% growth rate and 40% rate of return. Few companies are this dynamic, but potential growth and revenue are critical to how a company will be valued and how much money can be raised by an IPO and, most important, whether they will survive…
“The IPO market gives the outward appearance of a rebound but that is a false sense of confidence. The market is firming up and there are definitely upgrades but not all the signs are clear.” ~David Menlow