A Roadmap for an Entrepreneur, Stage 4: Going Public
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In the earlier three articles, we discussed how to create and grow a company. Having created value, a growing company with eminent prospects for future earnings may well think of going public. There are typically two reasons to go public:
To raise cash—Further growth may involve acquisitions, large marketing expenses, newer factories, and so on. All of these activities need cash, and the one of the best ways for a company to raise cash is from the capital markets.
To unlock the potential value of the company—The market may value the company at a much higher level if it goes public, thus benefiting the founders and the shareholders. This "exit" is often a key milestone event for founders, angel investors, and venture capitalists who have funded the company to date.
The process of going public is arduous and occupies a substantial portion of management time. In this article, we will focus on the process of going public in the U.S. capital markets. The process in other countries may be similar. In a fundamental sense, a company that is going public is offering to share the rewards of its business value to the public in return for investment. In order to attract such monies, the company has to identify in detail its earnings history, its prospects, and the risk to earnings. The statutory authorities such as the Securities and Exchange Commission (SEC) have obligations to protect the interests of the public by preventing weak or unstable companies from listing in public markets.
The IPO process is about a three-month cycle in the United States. However, the underlying activities for going public may well take several months ahead of the formal IPO process.
The key activities and considerations are:
Selection of "going public" team—The IPO team consists of company management, accountants, attorneys, and underwriters. The company needs to manage the IPO process as a critical company project, with a management team with assigned roles and responsibilities as well as well-defined reporting requirements.
Complete company records—Typically the company will need three years of audited financial statements, along with details of the company's accounting and revenue-recognition policies. The company should formalize a monthly and quarterly close process for its accounting books. Some of the key reporting items should include: sales volume, revenues and channels, list of major customers, gross margins by product line, departmental spending, and head count. The report should detail major balance sheet items such as accounts receivable, inventory, and assets. The company should also bring the stock ownership records up-to-date, including its stock ownership plan. Finally, you should have a well-written business plan and company presentation documents.
Create a suitable board of directors—The company's prospects with institutional and public investors are aided by the presence of blue-ribbon directors on the board. Typically this should be industry experts or executives with noncompeting products or services. This brings credibility and experience to the company and provides the company management the benefit of external good judgment and counsel.
Enhance your public presence—It is important to create the buzz about your company on the march to becoming public. Usually, a public company has severe restrictions on what it can say, whereas a private company is much freer to portray its successes and its prospects. It may be desirable to hire a public relations firm about six months before the IPO target date to seed the market with the potential of your company. It may also make sense to become more visible in trade shows, press interviews, and so on, to build the image of your company.
Hire proper counsel—The IPO process is a race with many legal hurdles to overcome. Choose corporate counsel who are experienced in this process.
Choose your underwriters—Public offerings are conducted by a group of underwriters. The company needs to select a lead underwriter to head the public offering. For a financial consideration, your underwriters will introduce your company to key institutional investors and wealthy private individuals. Some of considerations in choosing an underwriter: reputation, ability to distribute stock widely, experience in your industry, ability to "make" the market in your stock after you go public by maintaining liquidity in the stock, and ability to provide research about your company by providing investment analysts. The underwriters, in turn, look for a company that has the following: a good management team, a solid revenue history and prospects, a stable financial position, and a rational plan for usage of proceeds from the IPO. Underwriting is the expensive part of the IPO process; typical costs range from 5 percent to 10 percent of the money raised in the public offering. This is typically take off the top, once the money is raised. Underwriters may provide either a "best efforts commitment" to sell your stock or a "firm commitment" to buy the shares for subsequent resale in the markets.
Prepare the registration statement—In the U.S., this registration statement called the S-1 consists of two principal parts. Part I consists of the prospectus in a very structured form. This document serves two purposes: to promote the sale of stock and to detail the risks to purchasing the stock. Typically the sections will consist of the prospectus summary, the introduction to the company, a detailed business section, the risk factors, usage of proceeds, capitalization structure and dilution details, financial data, and management discussions. Part II of the S-1 form includes additional filings to disclose company sales of securities, articles of incorporation, by-laws, employment agreements, and so on. A preliminary filing of this is made to the SEC and is known as a "red herring" prospectus. The SEC review may take a month and may either approve or ask for additional clarifications.
Selling the stock—Once the S-1 is filed, the managing underwriter forms a syndicate of underwriting firms that agree to participate in the offering. Once each member of the syndicate makes commitments to participation, they all start "selling" to their clients. During this "quiet period" between filing and going public, the company is usually restricted from a number of activities: excessive advertising, reporting of anticipated sales, new partnerships not disclosed in the prospectus, and so on. The company management is expected to be on a "road show" to meet with members of the syndicate to help sell the stock to portfolio managers, security analysts, and key individual investors.
Closing the deal—Once the SEC approval is secured with an effective date, the deal moves to a close. The final price of the offering is usually fixed the night before the effective date by the managing underwriter and the company. This is intended to maximize the amount that can be raised under the best terms. The underwriting agreement is then signed by the company and filed with the SEC, enabling the transaction to go forward. The company chooses a registrar and transfer agent to handle the stock registration and transfer services. The lead underwriter manages the process of gathering funds and delivers the net proceeds of the public offering.
Trading as a public company—New responsibilities accrue to the management of a company once the company is public. The stock price is now a constant concern, and it is important to manage the perception of the stakeholders in your company: brokers, analysts, competitors, and shareholders. All material information (new deals, revenue dips, change in prospects, management changes, and so on) need to be reported in a timely manner, such as through an SEC for 8-K filing. Strict regulations exist for trading by the insiders, who can trade only during an "open window." There are quarterly filing requirements such as the SEC Form 10-Q.
Being Successful
A successful IPO is not the end of the road for the company. In fact, it comes with many strings attached. The company has to live up to the faith placed on it by the market. This faith is measured in terms of profits, market share, growth, and so on. The market will measure the company's progress every quarter. It will also watch every move made by the company in between quarters, for example.
- Who are the new customers?
- What are the new alliances being made?
- What's the project next quarter revenue and earnings?
- What's the revenue growth rate and earnings growth rate?
- What are competitors doing?
- Are the customers happy?
- Is anyone from the management leaving?
- Are there any lawsuits against the company?