The Climate for Initial Public
Offerings has Improved
The worst seems
to be over and investors are flocking back to the stock market; but
this time a bit wiser in their approach. Companies that held back
on launching Initial Public Offerings (IPO's) over the past three
years are now rallying their troops to structure the next great deal.
If you are waiting for the "ideal" time to go public, opportunity
may be passing you by.
Regardless of
the economy, savvy investors seek quality, and the same applies to
Initial Public Offerings. The difference between going public in the
1990's and taking a company public today is that the investment community
at large will not tolerate procedural deficiencies. The euphoria is
over, but selective opportunities still exist for those who understand
quality as well as the importance of attention to detail.
Typically, it
costs less to prevent a problem than to fix one. In-the-know business
owners and company principals took advantage of the market's "down
time" to plan their next move. Many adopted a "watch and wait" posture
but either way, the economy is on the upswing and this is being reflected
in the improvement of the major stock indexes.
Initial Public
Offerings serve an important business function. Speculative in nature,
they are designed to attract high-risk investors, particularly when
the companies going public have limited operating histories or no
track record of profitability. However, for a company going public,
the infusion of capital offers management an opportunity to accelerate
growth by hiring additional staff, conducting more research, and delivering
a greater range of products and services.
Although attractive,
there are still pluses and minuses to taking a private company public.
After all, companies seeking the infusion of capital that Initial
Public Offerings provide have a multitude of options including Private Placements
and Reverse Mergers.
Publicly Traded Companies Have
Advantages
·
Funds are obtained by the publicly traded company from the
offering, which can be used for working capital, performing research
and development, modifying equipment, retiring existing indebtedness,
acquiring other businesses or diversifying operations.
·
It is typically easier for publicly traded companies to raise
capital through secondary stock offerings.
·
Since stock is now available it is possible to enhance employee
compensation packages; improving the publicly traded company's ability
to attract skilled personnel.
·
A public market for a company's shares increases liquidity
for existing shareholders.
·
Publicly traded companies have a greater net worth, enabling
the company to obtain traditional loans on more favorable terms.
With Public Trading Status
Comes Responsibility
·
Public offerings can be expensive and time consuming.
·
Shareholders of publicly traded companies must be treated almost
as board members and kept up to date about the company's financial
state, potential management changes, and basically any other variable
that may affect the value of the company.
Although expensive and time consuming, keeping shareholders
informed is necessary to avoid potential liability.
·
Implementing operational changes to publicly traded companies
can take longer due to shareholder involvement.
·
There are many additional expenses and administrative problems
for publicly traded companies.
·
Publicly traded companies have a greater possibility of being
subject to lawsuits and claims.
Understanding the Initial Public
Offering Process
When a company
wishes to "go public", it faces a complex and challenging process.
The Securities Act of 1933 (the '33 Act) requires the registration
by companies selling securities to the public for the first time.
In a nutshell, the '33 Act is designed to prohibit the public distribution
of securities without disclosure of relevant information to the investor.
Once the decision
has been made to go public the company must select a managing underwriter,
legal counsel and auditors. Underwriters differ greatly in their experience,
background and existing customer base. In selecting the managing underwriter,
advice should be obtained from experienced advisors who have a background
in the area of public offerings.
It is vital
to investigate the aftermarket performance of the underwriter's prior
offerings. Without the appropriate aftermarket support the deal runs
the risk of collapsing or falling victim to "shorts" and "flippers,"
speculative traders who profit from the short term rally and decline
of IPO's. The managing underwriter must have a long term perspective
on the company going public.
Establishing Share Price
The proposed
Initial Public Offering price per share reflects a variety of factors,
including prevailing market conditions, the financial results of recent
company operations, the type of business it conducts, its future prospects,
its stage of development, its EBITDA (earnings before, interest, taxes,
depreciation and amortization) and an assessment of its management.
Typically, a company will be valued at a slight discount from established
companies in its industry.
The next decision
to be made pertains to the structure of the Initial Public Offering
itself. Most first offerings include common stock, although units
consisting of stocks and other convertible securities (such as warrants)
are also quite common. The two variables to consider are the number
of shares offered and the offering price per share. It is generally
believed throughout the investment banking community that a minimum
of 1,000,000 shares is desirable to create a public float large enough
to accommodate broad national distribution and support an active trading
market thereafter.
The issuing
price is more difficult to assess and depends on many factors, however,
the $5 level is often a threshold below which many investment bankers
and investors lose interest. In addition, many brokerage houses have
restrictions preventing brokers from trading in stocks below $5 per
share because they are viewed as possessing greater risk and more
inherent volatility than higher priced issues.
If a company
intends to have its stock listed on an exchange or the National Association
of Securities Dealers Automated Quotation (NASDAQ) system, the exchange
or NASDAQ will set the minimum share prices for initial listing and
continued trading.
Exchange Requirements Can Vary
Every exchange
has a myriad of listing and reporting obligations that must be satisfied.
For instance, the New York Stock Exchange requires a minimum aggregate
market value of publicly held shares for IPO's (which excludes shares
held by directors, officers, and their families and persons holding
10% percent or more of the company's stock) of at least $60 million.
The American Stock Exchange requires a minimum initial trading price
of at least $3 per share. The NASDAQ currently requires either an
initial trading price of $3 or $5 per share, depending on which set
of their financial requirements are met. The NASDAQ Small Cap Market
requires an initial trading price of $3 per share. Neither the Over
the Counter (OTC), Bulletin Board nor Pink Sheet markets have minimum
share price, number of shareholder or market value requirements.
The Registration Statement
The Registration
Statement is the disclosure document required to be filed with the
Securities and Exchange Commission (SEC) in connection with the Initial
Public Offering. The Registration Statement is a two-part document.
The first part is the prospectus, which is provided to the public.
The second part contains supplemental information which is available
to the public on the SEC website and EDGAR system. Many regulations
must be adhered to when drafting a Registration Statement, particularly
in regard to the accounting methods that may be used and the details
of various provisions.
The requirements
for a small business issuer (Form SB-1 or SB-2) are slightly less
cumbersome than the standard Form S-1. All Registration Statements
require audited financial statements for the previous two years that
must be updated and kept current throughout the registration process.
At no time during the process can the current financial statements
be more than 135 days old.
The Registration
Statement requires full disclosure pertaining to the company's business,
risk factors of the offering, management's discussions and analysis
of the company's financial condition, financial results of operations,
material transactions with insiders and use of proceeds raised in
the offering. The business description covers such matters as products
or services of the company, marketing and distribution, key customers,
relevant government regulations, management, employees and technology.
Information must be provided regarding the underwriting agreements,
plan for distributing the securities, identification of officers,
directors and control shareholders, and details regarding compensation
plans to management.
Legal Counsel Communicates
with the SEC
The Securities
and Exchange Commission (SEC) along with the Registration Statement
ensures fair and full disclosure to the investors. The SEC may not
and does not endorse the merits of the offering itself under any circumstances.
The company's legal counsel typically spearheads the preparation of
the Registration Statement and assists management in conducting due
diligence to ensure that the disclosures are accurate and complete.
Legal counsel
then files the completed Registration Statement with the SEC Washington
DC office where it is initially reviewed for proper form. SEC staff
members will then issue comments regarding real or perceived deficiencies
in the Registration Statement. Legal counsel then makes modifications
to the document until the SEC is satisfied with its structure and
content. Upon the SEC's satisfaction with the Registration Statement
it becomes effective and only then can sales to the public take place.
Indications of Interest are
Gathered
Although no
sales can take place during the time period that Registration Statement
is being reviewed by the SEC, the underwriter and other brokerage
firms participating in the deal can distribute preliminary prospectuses
("Red Herrings") to investors and collect indications of interest
to calculate how the offering will be received by the investment public.
A final version
of the prospectus must be delivered to each investor either before
or contemporaneously with the purchase of the stock. Moreover, the
Registration Statement must be updated and kept current until the
Initial Public Offering is completed, meaning the point where all
shares are sold. Severe civil and criminal liability may arise from
material misstatements or omissions in a Registration Statement when
it becomes effective, all the more reason that it is critical to retain
experienced legal counsel.
Ten Factors to Consider Prior
to an Initial Public Offering
An Initial Public
Offering is no small endeavor, but the financial rewards can be significant.
As with any business transaction it is best to go in with eyes wide
open so as to avoid common misconceptions and mistakes. There are
approximately ten key points to understand before undertaking an Initial
Public Offering.
1. Legal Counsel
Depending on
the size of your company, it is usually more cost effective to outsource
legal counsel. If your legal needs are sporadic or even ongoing, motivated
and effective legal counsel can be retained for approximately 50%
of what is costs to employ in-house counsel. It goes without saying
that with the advent of the Sarbanes-Oxley Act it is now more important
than ever to stay current with SEC rules and regulations. Companies
with even the best of intentions can find themselves in violation
of current rules and requirements without even knowing it.
It is critical
that companies seeking to achieve public status develop a relationship
with a securities attorney capable of guiding them through the complex
process of launching an Initial Public Offering. Remember, legal counsel
communicates directly with the Securities and Exchange Commission
as the company's liaison throughout the registration process and thereafter
should any problems arise while the stock is trading.
Corporate Counsel
Must Possess;
·
Extensive experience with both public and private companies.
·
A history of communicating with the SEC and NASD.
·
A strong working knowledge of accounting procedures.
·
Established working relationships throughout the investment
banking community.
·
At least ten years experience.
2. Management
Closely examine
your company's management team before considering holding your enterprise
up to public scrutiny. This may be a time to trim 'dead wood" and
ad that star player you've been considering. Upon taking your company
public investors as well as potential investment banks will want to
see biographies on most if not all of your management team. Put your
best foot forward and show the world you've got the personnel resources
to dominate your chosen field.
If potential
investment banks don't believe investors will be sparked by your corporate
management team, it may be difficult if not impossible to attract
interest from underwriters.
3. Selecting
Your IPO Team
An IPO is the
end-product of the collective efforts of a very skilled group of specialists;
investment bankers or brokers, legal counsel, independent financial
auditors, and stock transfer agents. As with any other scenario always
shop for talent and be sure to have the assistance of experienced
legal counsel who knows the right questions to ask. In many cases
an experienced securities attorney will already have strong working
relationships with the people you will need to work on your behalf,
including investment banker and the Securities and Exchange Commission.
Remember, your legal counsel is typically your point person; your
investment banker is strictly your vehicle.
4. Marketing
Investors are
less likely to rally to your cause unless they see you have the ability
to expand your client or consumer base throughout good economic times
as well as bad. It is essential for investors to know that you can
weather the storm and prevail amongst your competitors, creating and
maintaining a consistent growth rate so that they will hold onto your
stock as opposed to dumping it at the first sign of profit.
A strong marketing
effort tells the world that you aggressive in marketing your company
and your primary business expertise is highly focused and developed.
Unless you can show the investment public that you can generate new
business on an ongoing basis you run the risk of attracting investors
with a short-tem perspective on your company. This can result in a
stock that does well right out of the shoot, but falls flat and never
recovers. Any successful Initial Public Offering is built on the participation
of a solid investor base, one that is prepared to stay on board for
the long haul.
5. Disclosure
and Financial Reporting
Off-the-cuff
accounting practices were never looked upon favorably, regardless
of their popularity. Quality companies have always respected the fact
that in order to prosper over the long haul you must respect your
investor's capital with the highest regard. After all, investors have
more options than ever before as to where to position their capital.
Should they select to invest in your company you have a moral, ethical
and legal obligation to provide them with the most accurate depiction
of your financial situation.
Quarterly and
annual reports are the most obvious accounting responsibilities. However,
once you have gone public there are also proxies to prepare for shareholder
meetings. Although at first this level of accounting may seem intimidating
it is important to remember that it's all been done before. In business
there is rarely such a thing as a unique situation. The trick is finding
the right accounting firm for your particular scenario.
The best way
to go about this is probably the most obvious. Work with your legal
counsel to establish an accounting and reporting discipline and then
stick to it.
6. Expect the
Unexpected
Taking a company
public can take anywhere from six months to two years depending on
a variety of factors. There are also several different ways to get
where you're going including reverse mergers, filing traditional registration
statements and in some states a Rule 504 public offering will do the
trick.
There will be
interrogatories by the Securities and Exchange Commission (SEC), personnel
changes, business plans to be created, and ironically your company
must still function successfully in the interim. The benefits though
can be tremendous and like anything else, you get out what you put
in. If it was easy, everyone would do it.
All the more
reason to take into consideration the fact your legal counsel is your
cornerstone in creating your IPO. The hurdles that must be traversed
are complex but the right securities attorney can spell the difference
between success and failure.
7. Business
Model
The Road Show
is an opportunity for companies that are going public to show their
wares. Meetings and presentations are held at brokerage firms, industry
conferences and investment seminars. If the company's business model
is not cohesive, attendees will not rally to the cause.
Remember, investors
as well as brokers have thousands of options these days and Initial
Public Offerings do not sell themselves. If brokers do not believe
in your concept they are not going to put their valued clients into
the offering. The company's business plan must demonstrate the ability
to create and sustain growth as well as present viable contingencies
in the event that things do not go as planned.
When meeting
portfolio managers and investors, for example, you have to be able
to justify reasons for them to invest in your company. This is done
by noting the current market conditions, showing how and where your
company's product or service fits into a particular industry in the
market, and describing past, present and anticipated successes.
The most advisable
way to do this is to present your company's business model. Demonstrate
focus and flexibility and a strong working knowledge of product marketing.
Show them that the company has the ability to generate revenues on
a variety of fronts. In summary, be sure the business model makes,
possesses a strong factual foundation and is not based on lofty projections.
8. Name Recognition
Name recognition
is king from a marketing standpoint. As unbelievable as it sounds
though, even this aspect of undertaking an Initial Public Offering
has its drawbacks as well.
Name recognition
can attract more qualified employees as well as assist the company
going public to raise the capital needed to complete the offering.
Name recognition can bolster growth, secure publicity in the news
media and spark a myriad of cross-promotional opportunities with key
players in related businesses.
On the downside,
it can also make a company more vulnerable to public scrutiny in the
event a financial forecast is missed and the share price declines.
The investment public will not tolerate any negative news (unfounded
or not) that becomes attached to your company's name. In the same
fashion that product manufacturers are quick to dissolve relationships
with celebrity sponsors at the first hint of scandal, investors and
brokers will do the same to a company being dragged through the mud
in the media. In some unfortunate cases, rumors are enough to cause
a share price to plummet, undoing months or even years of hard work.
Companies preparing
to go public must have strong public relations and investor relations
machines in place. Perception is everything, especially when attempting
to maintain the faith and devotion of a widespread investor base.
Be sure that management is advised to never give statements to the
media without clearing the language with legal counsel first. Not
only can a misstatement send investors running for cover, but it can
also bring down sanctions by the Securities and Exchange Commission
(SEC) in the event that the misstatement causes a rally in share price
or induces buying from the general public.
9. Plan for
Unexpected Costs
Rest assured
that operational expenses will increase once a private company goes
public. Updating investors costs money; so does media relations, advertising
and legal. Company principals should clearly understand that launching
an Initial Public Offering may not equate to immediate revenues but
it will most certainly result in increased operating expense.
The company's
cash reserves should be able to withstand this initial outlay without
detrimentally effecting the company's reporting figures or "numbers."
Principals should take a long, hard look at the company's projected
budget, plan for every possible miscellaneous one-time expense and
then buffer that figure to compensate for unforeseen costs that invariably
arise.
10. Consult
with a Securities Attorney
The IPO is just
a transaction, but a large transaction. Legal & Compliance, LLC
can provide numerous options in regards to company financing. If indeed
an Initial Public offering is the way to go, our team will work closely
with company management to create and implement the best possible
strategy for taking your company public in a timely and cost-effective
manner.
Over the years
our firm has developed key relationships with established professionals
in the investment banking community including underwriters, investor
relations experts, marketing and corporate image entities and stock
promotion companies. We are accustomed to preparing Registration Statements
in a timely fashion while communicating with key personnel at the
Securities and Exchange Commission. These relationships allow us to
move aggressively on behalf of our clientele when bringing an exciting
new issue to the market.
Related Stories
Due Diligence and
Initial Public Offerings >>
