Preparing Your Company to Go Public

Overview  

How would you like to join a very exclusive financial club where the members represent .001 percent of all of the businesses in the country? The members of this club are companies that have gone public. Why is this group made up of such a small percentage of corporations? Because completing an initial public offering (IPO) is tough, expensive and complex. It can also be mysterious and confusing because it involves the disciplines of accounting, financial reporting and security law, and the average entrepreneur usually does not have expertise in these areas.

As a result of the phenomenal success stories of technology and Internet-related IPOs during the past few years, the business world, the media and Americans in general have become infatuated with the stock market. In fact, our country's obsession with Wall Street is luring business owners from every industry to the public market.

This article will help you decide whether going public is right for your company, and provide an outline for preparing to take on the public market.

Outline:

  1. Why Go Public?
  2. Factors to Consider
  3. Getting Prepped
  4. A Timeline for the Process
  5. Alternatives to Consider
  6. Resources


I. Why Go Public?

When considering whether or not to go public, you should first ask yourself what your motivations and objectives are. If your reasons are to gain the glamour and prestige that comes along with a successful offering or to keep up with competitors within your industry that are going public, you should think twice. While going public is considered an acknowledgment of success, since typically only high-growth, hot companies can do it, this is not a decision to be entered into lightly — and you don't want to enter into it for the wrong reasons. Although it is tempting to want to share in the type of fortune and fame that comes along with a lucrative IPO, especially after the past several years of phenomenal offerings by technology and Internet companies, you have to consider what is best for your particular company.

There are many sound reasons for wanting to go public. For instance, equity capital obtained from an IPO is considered a permanent form of capital since there is no interest to be paid on the equity, and it is not repayable like debt. Therefore, funds generated by a public offering are considered a relatively "safe" form of capital for a business. Going public can also allow a company the freedom and flexibility to spend capital as it needs to finance its growth and further development, providing a solid financial base on which to build. Equity capital from an IPO also allows a company to exploit its market opportunities while they are present — before competitors are able to seize them.

So if you want to take your company public to raise growth capital — and you have explored all of your other alternatives for doing so — then you're starting out on the right track.

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II. Factors to Consider

In deciding whether going public is right for your company or not, there are several important factors that you should consider. There are also many legal considerations, but they are beyond the scope of this discussion. It is  best to talk them over with your attorney.

First, and perhaps most important, your company must have what is known as "investor appeal" or "sex appeal." Quite simply, this means that your industry, services, or products must be in hot demand by individual or business consumers, which in turn puts them in hot demand by investors. Such hot companies and industries show the potential for outstanding growth, which translates into handsome returns for investors. Currently, the industries that have such appeal are Internet-related companies, such as service providers, and those that deal in electronic commerce, bandwidth and wireless. Other hot industries are  biotechnology, communications companies, software developers and restaurateurs.

A few more things that will make your company sexy to investors are: having a proprietary product or service; being first on the market; and absolute, exclusive control over a proprietary product or service protected by patents, copyrights, trade secrets or private formulas no one else has or is likely to get anytime soon.

Anything that gives you a very competitive or "unfair" advantage over your competition is what you are after. It also helps to have your market easily identifiable, as well as easily explainable to prospective investors.

Esoteric products and services sometimes lose their sex appeal in the translation.

Although it seems that investors' tastes vary from year to year, there are those that specialize in particular markets, such as health care or employment services, on an ongoing basis. Simply doing your homework on the Internet or by scouring newspaper headlines at your library will tell you whether or not your company falls into a category that currently has investor appeal. If it does not, perhaps the timing is wrong for a public offering, or perhaps there is a way that you can parlay your existing company into a hot market.

You can find additional information about companies that have investor appeal at IPO Central, Red Herring, and TheStreet.com.

Next, it's important to realize that your company will undergo some significant changes after an IPO, not the least of which is caused by the influence of your investors. You will be subject to their ideas, opinions and demands on how you should run your company. More likely than not, decisions will still be made in team fashion, with your preferences weighed heavily, but it will no longer be just you running the show. If you are not willing to turn over at least partial control to these individuals, or you do not trust that they will make good decisions for your organization, you may want to think twice before taking the plunge.

Your company will also be put under a microscope by investors, customers, competitors, the media and so on. As the head of a public company, you will be required to disclose quarterly financial statements - including your own salary and other sensitive information. As a result of providing this window into your company's performance, you will be in the position of having to explain negative performance, such as lagging growth or sagging sales, to keep investors satisfied. Many investors will be comfortable with minor downturns in your business as long as you keep the lines of communication open and can prove that the situation will be rectified in a reasonable amount of time.

Additionally, going public will change the entire dynamic within your organization. Everyone on staff may feel compelled to live by the day-to-day changes of your stock price, taking their time and attention away from their jobs. And they may panic even at minor fluctuations in the market that are out of your company's control. It is more important than ever in such situations to maintain open communications among all of your staff.

Last, you should also consider the toll going public will take on your professional and personal life. Because it is such a time- and energy-intensive process, it will likely distract you from your role of actually running the company and eat into the time you currently spend with family and friends. While these may seem like minor issues, it is important to know what you're in for. You don't want to be surprised later when you're spending the majority of 12- and 14-hour days on your IPO.

Self-Assessment: Have You Considered All of the Factors?

Answer the following questions to determine whether you have considered all of the downsides of going public:

  1. Does my company and industry have investor appeal?
     Yes  No
     
  2. Does my company have any of the following investor-attracting properties: proprietary product or service; being first on the market; absolute, exclusive control over a proprietary product or service protected by patents, copyrights, trade secrets or private formulas?
     Yes  No
     
  3. Am I and my management team willing to give up a large percentage of the business to investors?
     Yes  No
     
  4. Am I willing to turn over at least partial decision making control to a team of outside investors?
     Yes  No
     
  5. Am I prepared to share confidential information including all my financial statements with the public?
     Yes  No
     
  6. Can I keep up with the ongoing demand for information from investors?
     Yes  No
     
  7. Am I willing to share future profits with investors?
     Yes  No
     
  8. Do I have an open communication style with my staff to eliminate any concerns with the going public process?
     Yes  No
     
  9. Am I willing and able to give up significant amounts of my personal and professional life to undergo this process?
     Yes  No

If you answered "No" to any of the questions above, you should carefully re-evaluate your willingness and ability to do an IPO at this time.

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III. Getting Prepped

While the going public process is often wild and unpredictable, there are some steps you can take to prepare for it. They include the following:

  1. Financial Reporting - Unless your company is a startup, going public requires that your books be in order with quarterly, audited financial statements. However, preparing for regular financial reporting could be a stumbling block if you and your management team do not have accounting experience. As a pre-IPO, then, you will need to bring in a professional and accredited accounting firm that has a reputation that meets the expectations of investors and investment bankers (the people who help you go public). The reason behind all of the scrutiny of your books is that investors and the regulatory agencies want to know that your financials are truthful and accurate.  

  2. Economic Considerations - Investors want to make money, and the only way to do that is to invest in a company that will make money. As a pre-IPO, you have to show investors that either you are presently showing impressive revenue growth or have the ability to do so in the near future.
  3. The main economic indicators that prove your company's ability to make money for investors are rate of growth and net profit margins. These figures show how quickly you can grow and how much profit you can make on your revenues. Keep in mind that although when you were a private company you wanted to show as little profit as possible to save on income taxes, as a pre-IPO, you want just the reverse. You want to do everything in your power to show a good return on your sales. That might mean cutting costs, improving your inventory turnover, or boosting your revenues by adding products or services. Whatever you have to do to show better revenues and earnings, now is the time to do it.

    Remember that you are giving away a piece of your company to the public. What they are willing to pay for it depends on your profits and rate of growth. The better your growth and profit statistics, the higher the price you will get for your stock, the less equity you will have to sell, and the more money you will raise. For additional reading on this topic, see Analyze Profitability and Financial Ratio Analysis.

  4. Personnel - As you continue in your IPO preparations, take a look at who is running the show at your company. Who are the key players on your team? What is their background and experience to implement your projections? The founders and advisers should boast strong credentials in their field with excellent management histories showing consistent profitability.
  5. If, after taking a good look at your organizational chart, you find that there are holes, plug them! Now is the time to strengthen your management team and surround yourself with the best staff possible. For assistance, see Hire for Success.  

  6. Costs - You might have guessed that the IPO process is going to cost quite a bit. Besides all of the internal preparations, there are legal and investment banker's fees to consider. A good ballpark figure that you will have to spend before you get any capital from the offering would be around $100,000. Obviously, taking a company public is not something to do on a shoestring. Take the time now to determine where those funds will come from. If you do not have the capital in your reserves, make a plan for how you will obtain it.  

  7. Attracting Investment Bankers - These are the people who draft your prospectus, assist with the filing, solicit interest from investors, determine the price at which the shares can be sold, and sell your offering to the public. Most IPOs are "best efforts" - that is, the underwriter will do their best effort to sell the IPO but will not guarantee the results. In a true underwriting, usually done for larger and stronger companies, the underwriter actually purchases the shares of stock from the company at the offering price, less their discount, and sells the stock to the investors. Their compensation is usually made up of a percentage of the offering (money raised) and options to buy a small amount of stock in the future. Do you need them? Absolutely, if you can find them. To the successful investment banker with a track record of IPOs, it is not whether you want them, but rather whether they want you.
  8. The number one criteria used by investment bankers to decide if you are ready to go public is whether you have already developed a working model of your business. This means you are selling your products or services and servicing those sales and can also demonstrate the potential to roll out your economic concept on a national scale or major regional scale.

    When trying to attract an underwriter to take your company public, you should not only stimulate interest by explaining the potential of an investment in your company, but you should also reduce the perceived risk to the lowest possible level by explaining how an investment in your company will strengthen your position in the market.

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IV. A Timeline for the Process

Barring any unforeseen events, it usually takes about a year to do an IPO from start to finish. Note that market timing is everything, however, and if the market is not performing well, you may want to hold up the process until it recovers.

Here is a breakdown of how the process typically unfolds, month by month:

Month #1 - Create a professionally written business plan that describes the reason for raising capital, how you will use the funds, and how it will improve the company. This will be the first thing potential investors get to know about your company, so make sure it is well-written.

Months #2, 3, 4 - Shop the plan around to attract an underwriter. It typically takes three months because you will have to do your homework to find an underwriter who shares your philosophy and understands your goals and concerns.

Months #5, 6, 7 - Write the offering prospectus and undergo due diligence with your underwriter. These steps are best handled by an attorney and are beyond the scope of this article.

Months #8, 9, 10 - Get necessary regulatory approvals from the Securities and Exchange Commission (SEC).

Months #11, 12 - Bring all parties together — lawyers, regulators and investment bankers — to do a "road show" for the potential underwriters, brokers, dealers and institutional investors. During this stage, you and your management team will spend one to two weeks traveling around the region or country doing a whirlwind series of short presentations to drum up interest in the sale of your stock.

When you are finished with the road show, you will be ready to make your offering.

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V. Alternatives to Consider

There are a couple of alternative routes you can take to enter the public arena that may be easier and quicker for your company. They include:

Direct Public Offering

What do you do if you can't find an investment banker to underwrite your offering? The answer is something every entrepreneur knows by heart: do it yourself. There is such a thing as a direct public offering (DPO). This usually means you are selling your stock yourself. Where do you find the investors in such a scenario? You can start with your own customers or suppliers. If that is not enough to bring in all the capital you need, you can also try the Internet. It is inexpensive, and there are great Web sites that attract investors looking to buy IPOs. Sites such as IPO.com and Direct IPO offer companies the opportunity to reach investors without the expense of an investment banker by placing their private placement or IPO online.

If you are wondering why you should pay an investment banker using the traditional route if you can do it yourself, the answer is the same as if you were asking, "Why hire a lawyer; why not defend myself?" Or even better, "Why use a doctor; why not heal myself?" It is always wise to get a trained expert to assist you if you can afford to do so.

Reverse Merger Into a Public Shell

You can also literally buy the shell of an existing public company to become — in the eyes of the law — a public company. The trouble with this technique is that while your company does become public, it does not get any fresh capital out of the transaction. Yet you still have to spend considerable time and money on the process. Under this type of arrangement, your shares will trade but without that new capital on your balance sheet, you will probably be undervalued and end up just another penny stock. Be cautious when offered this solution by any investment banker.

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VI. Resources

Web Sites

IPO.com

Direct IPO

stockup.com

Books

James Arkebauer, "Going Public - Everything you Need to Know to Take Your Company Public" (Dearborn Financial Publishing, 1998)

Frederick Lipman, "The Complete Going Public Handbook" (Prima Publishing, 2000)

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Copyright , 2000, L2S Inc.