IPO – Some Steps and Alternatives

During the Pandemic many SMB leaders are taking stock of their businesses and even their entire legacy. Perhaps it is also time to consider an IPO.

In the past year, the Securities and Exchange Commission enacted new rules to make the process easier; however, only one in four companies follow through and complete the arduous process.

IPO pros include a liquidity event for shareholders, access to financial markets, added prestige, and ability to attract top talent makes it all worthwhile.

On the flip side, an IPO also means additional financial reporting and shareholder scrutiny. 

With these possible obstacles, the question any SMB leader needs to ask him or herself is the added expense and requirements worth the effort for the advantages.

If you do decide to move ahead, here are some things to consider while navigating the IPO path.

For an IPO, a company goes through a series of steps that can last several months to years. You probably will need accountants, lawyers and investment bankers to help you through the process.  Here are some steps as well as benefits and drawbacks to an IPO:

Have your company valued by a reputable third party. Accountancies and others specialize in this field.

But first do your own valuation of assets, intellectual property, and other things of value.  And, consider outstanding liabilities.  By going through this activity, you will one have a ballpark number in your mind; and two pull together many of the requisite documents the evaluator is going to ask for.

Engage your own lawyers to check all documents for intent, compliance and completeness.

Select an investment bank to guide you through the process; they receive a fee of 4-7% of money raised.  They help your company prepare an S-1 (a prospectus required by the Securities and Exchange Commission (the “SEC”) that provides a deep dive into the company’s financials, future plans, and its team) and line up a one- to two-month-long roadshow to pitch investors on the company. Those investor meetings gauge investor demand and help bankers determine an offering share price; also helps to decide the number of shares to be offered.

Usually there is a “lockup” period of 90 to 180 days, depending on the agreement with investment bankers. That lockup period prevents employees and early investors from selling their shares before that time, giving confidence to new investors that this is indeed a good place to put their money.  It is important that employees and investors stay mute during this period.

The initial public offering is expected to take place after the SEC completes its review process, subject to market and other conditions.

Benefits

An IPO lets you raise capital by reaching a large number of investors. The money is available right away via your investment bank.  Plus, there is the benefit of added publicity and attention from Wall Street analysts, which can generate demand for your company’s shares.

Drawbacks

IPOs are expensive and time consuming: on average, companies spend $750,000 and 18 months preparing for an IPO.  And there have long been complaints from companies pricing to high or too low on opening day: coming out under your IPO price can tank your company’s valuation; and too low will lead to a stock price ‘pop’ but less money raised for the company.

Shareholders need to consider and advised on tax consequences of cashed in shares.

But, let’s say you want to take your company public without the fan fair, time and money involved in an IPO.  Three ways to do so are direct listing, Dutch auction, and reverse merger.  Let’s briefly explore theses IPO alternatives.

Direct Listing

The direct listing is the current IPO favored alternative. It lets you avoid many of the headaches of an IPO and go public without issuing new shares. Instead, you sell a small amount of existing shares direct to the public once listed on an exchange; it is an efficient way for early investors to sell some of their stakes. 

With a direct listing, you still file the S-1 prospectus for investors like you do in an IPO, although you don’t necessarily need an investment bank to do underwriting or a traditional roadshow.  Instead consider having an “investor day” to educate prospective investors.

Unlike an IPO, the share price isn’t set in advance and existing investors can sell shares directly to the public without the traditional lockup period.

Benefits

You pay financial advisory fees, which are usually a lot less than the fees you would pay to investment bankers for the IPO.  Also, there is no lockup period means early employees and investors can sell shares right away.

Drawbacks

Unless your company is already well known, it may be difficult to drum up investor interest without the help of the investment banks, who become your cheerleaders when you pay them IPO fees.  You may also deal with additional scrutiny from the SEC, not yet accustomed to this nontraditional approach.

Dutch Auction

In a Dutch auction, the seller specifies the number of shares for sale and then sets a minimum bid price. Bidders, then in turn, state how many shares they’ll buy and the price they’ll pay.  The winning bidders pay the same price per share, or the clearing price. In IPO terms, what that means is that instead of having investment bankers determine what investors might be willing to pay for a stock, the investors themselves decide what your company is worth.  Despite big companies like Google utilizing, only a handful of companies have used them to go public.  These days, Dutch auctions are primarily used when a public company buys back some of its shares.

Benefits

A Dutch auction lets the company get the going market rate for its shares, without worrying about an investment bank underpricing shares to get an opening day IPO “pop” that rewards their best customers.

Drawbacks

Some experts deem such auctions as risky, because the seller has no way of knowing how many people will buy shares, and there is more uncertainty about the stock price.

As Wall Street’s ibankers does not make as much money on a Dutch auction, your company’s debut on the public markets might not be well received.  Plus, a Dutch auction takes away much of the ibank’s ability to determine pricing.

Reverse Merger

A quiet way to become a public company is by your private company taking control and merging with a public company, often a dormant shell corporation that doesn’t have assets or real operations, but does have a stock ticker symbol.

While the SEC has cracked down on the Reverse mergers, after several reverse-merger companies – including some foreign firms that used the practice to enter U.S. markets – to scam investors; there are legitimate companies, such as Dell, which reentered the public markets this way.

Benefits

A reverse merger has long been considered one of the most cost-effective and fastest (1-4 months) ways to go public.  Original or early investors can gain liquidity, plus the company can raise new capital through a secondary offering.

Drawbacks

The reverse merger has gotten harder to pull off successfully. Unless the company meets stringent requirements, the NYSE and NASDAQ will not list surviving reverse merger companies for one or more years after the merger.  Also, without analyst attention and the publicity of an IPO, the stock may suffer.

Finally if you are not careful, your company may inherit problems, such as litigation liability, from the shell company.

As you consider taking your company public, carefully weigh the financial, time and other commitments before moving forward.

A successful IPO, or taking your company public company through one of the alternatives, is worth the headaches for many business owners.