The Decision to go Public: Opening the Window of Opportunity
Sales are on the rise, gross margins are strong, market share is growing. You want to retool your manufacturing operation, expand your distribution network, add new products or services. You need liquidity, an improved debt to equity ratio, access to public financing markets or cash. You could borrow the money, franchise, merge with or acquire another company with the cash or approach private or venture capital investors. Or you could take your company public.
The Initial Public Offering
An Initial Public Offering, or IPO, is the first sale of stock in a company to investors in the public markets. Before a company can "go public," it must first register its shares for sale with the Securities and Exchange Commission and, sometimes, with selected state securities agencies. When the SEC has declared the registration statement effective, one or more investment bankers (underwriters) will agree to purchase shares from the company at a discount in the expectation of reselling them to the public at a higher price. Once a company has gone public, it must regularly share financial and other business information with investors and potential investors.
What It Takes
Going public takes patience, determination and many months of effort. Have your second thoughts first. To increase the chances for a successful offering, a company will want:
- A history of strong financial performance
- Growth potential
- A solid management team
- An experienced team of professional advisors, including lawyers, investment bankers and accountants
- A strategic vision and well-developed business plan and
- Favorable financial market conditions.
What It Costs
IPOs produce large sums of capital. A $10 million offering is considered relatively small on Wall Street. Some underwriters profess to be interested only in IPOs of more than $30 million.
Total costs generally run between 9 and 20 percent, depending on the size of the deal, the complexity of the company and the difficulty in selling the stock.
The largest cost will be the underwriting discount, which can vary from 7 to 13 percent, sometimes including a nonaccountable expense allowance. Underwriters may also receive warrants to purchase company stock.
Legal fees and accounting fees often exceed $200,000 each.
Printing costs often range from $75,000 to $150,000.
SEC and state registration fees can reach $20,000.
Additional fees including listing fees on a stock exchange or quotation fee for NASDAQ, travel expenses and transfer agent fees.
How It Works
Generally, the IPO occurs in four phases:
Planning — Assembling the team, preparing necessary documents and reaching a general but nonbinding understanding with the managing underwriter.
Preparation — Drafting the registration statement, including the prospectus, for review by the SEC and, in some cases, state agencies.
Marketing — Company management and the underwriters go on a "roadshow" to visit brokers and potential investors.
Closing — The SEC declares the registration statement effective, the price is set, shares trade in the public market, the sales to the underwriters close and the company is public.
Taking your company public is no easy task. It takes time. It takes money. More than anything it takes teamwork. Companies take months, sometimes years, planning to go public. Planning includes three activities:
Pick a Top-Flight Team
Select experienced securities and corporate counsel to review your corporate structure, help negotiate the underwriting agreement, take primary responsibility for drafting the registration statement and work with the SEC.
Experienced accountants will make sure your financial statements comply with Generally Accepted Accounting Principles (GAAP) and SEC requirements. Your accountants will analyze the accounting impact of proposed compensation and other business arrangements and help respond to SEC accounting comments.
Now is the time to consider additions to the management team.
Put Your House in Order
From the moment you decide to take your company public, you should begin to put your corporate house in order.
Consult your lawyers about changes to the company's articles of incorporation and bylaws in preparation for public company status. Issues might include shareholder control, board authority and antitakeover provisions.
Review prior financings. Do they comply with securities laws? What registration rights or rights of first refusal exist?
Examine executive compensation. Stock option grants may conflict with blue sky regulations or cause accounting headaches.
Complete audits (three years of financial statements needed) and prepare unaudited "stub" period financial statements.
Shake Hands with Your Underwriter
The selection of the right managing underwriter is critical to the success of your IPO. This key business partner provides credibility for the company to potential purchasers, particularly institutional investors, and assembles the right syndicate and selling group to get your stock into the hands of the best mix of shareholders. Once you are public the underwriter should continue to follow the stock with a respected analyst and provide informal financial advice.
The planning phase is complete when the company and underwriter have concluded negotiations on the basic terms of the underwriting — approximate size of the offering, anticipated price per share and underwriting fees and expenses.
These terms are sometimes documented in a letter of intent. The underwriter, however, is under no obligation to purchase the company's stock until the SEC declares the registration statement effective and a formal underwriting agreement is signed.
After counsel and underwriters gather facts about your company, a prospectus is prepared for SEC review. Your exposure to the public spotlight begins. Selection of a managing underwriter signals the beginning of even more activity for management, counsel and other key advisors.
Under the Microscope
The underwriters, their counsel and your counsel will review a broad range of company documents. Financing agreements, financial statements, budgets, shareholder lists, agreements with vendors, landlords, lenders and others, marketing and business plans and similar documents are all subject to review. During this period, the managing underwriter will also be talking to key customers, suppliers, distributors and others familiar with the company's business and industry as well as those in a position to judge the quality of the company's management. For the underwriters, the process is part of their "due diligence" investigation.
Of Registrations and Red Herrings
Before stock can be sold in an IPO, a registration statement must be filed with the SEC. The registration statement consists primarily of a preliminary prospectus known as a "red herring." The preliminary prospectus includes information about the use of offering proceeds, financial statements, a description of products, services and marketing, competition, management, principal shareholders, and frequently, a section devoted to special risks of investing in your company. In addition, a section called the "MD&A" contains a detailed analysis by management of the company's financial results and condition. While the preliminary prospectus will include an estimated offering price range, the final price will not be added until the underwriting agreement is signed and the final prospectus is prepared.
Filing with the SEC
The completed registration statement is filed with the SEC, appropriate state securities agencies and the National Association of Securities Dealers, Inc. (NASD).
As the SEC reviews your prospectus, you take to the road to convince brokers and big buyers that they should hitch their money to your rising star. Once the company has filed the registration statement with the SEC, a number of events occur:
Under the Microscope II: SEC Review
The SEC reviews the registration statement for sufficiency of information to investors and compliance with SEC disclosure guidelines. The result is usually a comment letter that is answered, after discussion with the SEC, with one or more amendments to the registration statement.
State blue sky reviewers address not only the sufficiency of disclosure but the fairness of the offering. Companies listing shares on the Nasdaq Stock Market, the New York Stock Exchange or the American Stock Exchange are not subject to state review.
The NASD reviews the arrangements between the company and the managing underwriter to assure that compensation to the underwriter does not exceed NASD guidelines.
Looking for a Listing
The company needs a continuing market for its shares after the offering. Options include the New York Stock Exchange, the American Stock Exchange, a regional exchange or the Nasdaq Stock Market.
While the SEC completes its review, the managing underwriter and key company officers conduct the road show — a series of presentations to brokers and institutional investors throughout the country (and in some instances internationally) to generate enthusiasm for the company and obtain "indications of interest" in the stock. (Actual sales are not permitted until the SEC declares the registration statement effective.)
The one- to two-week schedule can be grueling, often involving stops at more than one city each day. The timing of the road show is designed to heighten investor interest just when the registration statement becomes effective.
In addition, the preliminary prospectus is distributed to potential syndicate and selling group members, institutional investors, some retail customers and the financial press.
The SEC review is complete. You and the managing underwriter agree on a price. Your registration statement is declared effective and selling begins.
It's Official: You're Public
The registration statement has been amended to satisfy SEC comments. The underwriters select the date they wish the SEC to declare the registration statement "effective." Underwriters and company officials carefully analyze the market and, the evening before the effective date, agree upon a share price and underwriting discount.
The Underwriting Agreement is signed.
The registration statement is declared effective.
The stock appears on Nasdaq or an exchange.
Trading begins. Confirmations, along with copies of the final prospectus, are sent to purchasers.
Approximately five days after the effective date, the sales to the underwriters close, and the company receives its money in exchange for stock. IT'S TIME TO CELEBRATE.
From Private to Public Eye Shareholder relations - Now, instead of reporting to a few investors, management is responsible to hundreds, perhaps thousands, of new "owners" who expect a good return on their investment. The company may feel pressure at times to focus on short-term gains to the detriment of long-term goals. The potential for shareholder lawsuits increases.
Reporting responsibilities - SEC regulations impose strict reporting requirements on public companies. Quarterly and annual reports must be filed with the SEC. An annual report must be sent to all shareholders.
Insider trading limitations - SEC restrictions also limit the ability of officers, directors and others with significant access to company plans to trade in the company's stock. Civil and criminal penalties apply.
All Hands Meeting
A meeting of personnel from the issuer, its counsel, the investment bankers, their counsel, auditors and other experts and hangers-on. The first of such meetings may be the last chance to see your senior investment banker before the closing dinner, so pay attention.
Blue Sky Laws
State securities laws. Named after a 1911 Kansas law aimed at promoters who "would sell building lots in the blue sky in fee simple."
Stock sold by the company to insiders prior to the public offering at prices substantially below the public offering price. Compensation expense can create accounting issues or Blue Sky fairness questions. Options granted with exercise prices below the fair market value of the company's common stock can raise similar issues. The term is sometimes used by company insiders to refer to the stock to be sold to the public.
As in "Cold Comfort Letter." Response by the auditors to a request by the underwriters for assurances that the financial statements are in accordance with generally accepted accounting principles (GAAP) and that certain other numbers are accurate or at least match some number the company is willing to present to the auditors in writing.
Confirmations of sale sent by selling brokers to those customers who have purchased company stock, which triggers the obligation of the customer to send in money. Confirms cannot be mailed unless accompanied by a final prospectus, which is printed only after the registration is declared effective by the SEC. Hence the pressure to get the final prospectuses into the hands of the selling brokers.
Practice whereby friends, family members, and others professing a long-term interest in your company sell your stock within a week of its purchase (arranged by you after some pleading with the underwriters) when the chance for a ten percent gain presents itself.
Green Shoe Option, the "Shoe," the Overallotment Option. An option granted to the underwriters to purchase up to 15 percent more shares to cover overallotments; i.e. overbooking by the underwriters. A place to camouflage sales by insiders. Named after the Green Shoe Company. Your investment bankers will convincingly explain the need for the green shoe, but you will recall nothing upon waking.
Publicity about the company and the offering, particularly if generated by the company before filing the registration statement or, if after filing, that reports information not in the preliminary prospectus. The SEC may view this publicity as unfairly influencing prospective investors and, as a result, delay the offering.
Agreement by insiders or selected investors in the company to refrain from selling shares of company stock in the open market prior to an agreed upon time (often 180 days from the commencement of the public offering).
The practice of filing a registration statement with the SEC without a press release, public announcement or other fanfare. Used when the disclosure has not been finalized or unresolved issues may make it inadvisable to proceed with the offering. The term is heard less often today because most filings are made electronically with the SEC and are therefore more readily accessible to the public.
Refers to the period immediately following the public offering in which brokers and others are required to deliver the prospectus to purchasers of the stock. The term implies that the company should refrain from saying anything about its business that might be inconsistent with, or otherwise not included in, the prospectus.
The Preliminary Prospectus, the "reds." The name derives in part from the restrictive legend printed in red on the prospectus cover. May be circulated by the issuer and the underwriters after a registration statement is filed but before it is declared effective. Where the issuer describes itself as it would like to, before the SEC suggests how it really ought to be described.
The group of investment bankers assembled by your managing underwriters that will agree to buy stock in your company at a seven to ten percent discount after they have found others who will buy it at the full price.
For More Information:
- Robert Moorman (Portland) (503) 224-3380
- Christopher J. Voss (Seattle) (206) 624-0900
- Paul Boyd (Boise) (208) 398-9000
- Reed Topham (Salt Lake City) (801) 328-3131
This material is intended for general informational purposes only and should not be construed as legal advice or a legal opinion on specific facts or circumstances. You are urged to consult an experienced lawyer concerning your particular factual situation and any specific legal questions you may have.