BU628 – Strategic Finance
November 11, 2007
IPO White Company
Overview of Company
The current business climate of the company is favorable. Sales and Production are operating at a satisfactory level in order to maintain current market share and profit. Opportunities for additional growth seem possible since the industry is still viable and in fact is growing.
The Initial Public Offering
The Initial Public Offering (IPO) is the first sale of stock by a company to the public. We are therefore switching from private ownership to public ownership. This involves offering part ownership of the company to the public through the sales of debt or more commonly, equity securities (stock). Going public raises cash and provides many benefits for the company, such as opening financial doors. The reason for this is because of the increased scrutiny of public companies, public companies can usually get better rates when they issue debt. As long as there is a market demand, a public company can always issue more stock. Thus, mergers and acquisitions are easier because stock can be issued as part of the deal. Trading in the open markets means liquidity. This makes it possible to implement things like employee stock ownership plans, which help to attract top talent for the company.
Advantages and Disadvantages
There are six points on advantages and disadvantages that the company should be aware of before going public. These are not all inclusive! Although the advantages are always welcome the disadvantages should also be considered. We will have a stronger capital base but a short-term growth pressure. An increased financing prospects while disclosing finances and less confidentiality. The company will be better situated for making acquisitions but we will have initial and ongoing costs. We will have a great owner diversification with restrictions on management. Management will have a great executive compensation, but loss of personal (private company) benefits. An increase in company prestige and trading restrictions are another facet of the pros and cons of going public.
Qualification, requirements, and registration process
The first thing the company should do is to talk with an underwriter, IPO consultant, accountant or attorney about the market prospects, as the atmosphere for making public offerings is always in flux. A few questions that management should ask themselves:
Can I show that my company can maintain consistent high growth?
Is the public aware of our type of product or service? Do they think it’s in a “hot” industry?
Can our company perform as well as and preferably better than our competition?
Can we meet the financial audit requirements?
Many underwriters require that the company is generating sales of $10 to $20 million annually with profits of $1 million. That your product is on the "leading edge" and that you have an experienced, proven top management team and can show future growth rates of at least 25% annually for the next five years. To obtain a NASDAQ listing, you need $4 million in tangible net assets. However, there are a lot of exceptions and smaller companies can also become publicly held.
Audited financials and a good management team will help the company towards its initial public offering. The creditability and experience of the company’s management team is the most important key in obtaining an underwriter and successfully completing a public offering. The company will also need a good outside team. These are the IPO consultants, accountants, attorneys, underwriters and Public Relations specialists.
Going public requires a Registration Statement, which is a carefully crafted document that is prepared by your attorneys and accountants. It requires detailed discussions on information pertaining to:
Business product/service/markets
Company Information
Risk Factors
Proceeds Use How are you going to use the money)
Officers and Directors Related party transactions
Identification of your principal shareholders
Audited financials
After the registration statement is prepared, it is submitted to the Securities and Exchange Commission (SEC) and various other regulatory bodies for their detailed review. When this process is completed, the company’s management team will do a "road show" to present the company to the stockbrokers who will then sell the company’s stock to the public investors. Assuming they can successfully sell the company’s issue, the company will receive the needed money. At this point, there is only one simple plan: turn a profit so to increase the value of the company and the shareholders ownership.
Costs
Cost can vary considerably depending upon an individual company's history, size and complexity. The following figures are considered minimums and many larger offerings will have costs that greatly exceed these numbers.
Legal - $50,000 to $150,000
Accounting - $20,000 - $75,000
Audit $30,000 - $200,000
Printing - $20,000 -$80,000
Fees $10,000 -$30,000
Plus underwriter commissions and expenses as well as numerous expenses on the part of the company.
The timeframe for going IPO can take from 3 to 12 months; the average of a well-prepared firm is 6 to 9 months.
The Underwriting Process
Underwriting is the process of raising money by either debt or equity (in this case we are referring to equity). The biggest underwriters are Goldman Sachs, Merrill Lynch, Credit Suisse First Boston, Lehman Brothers, and Morgan Stanley. The company and the hired investment bank (the underwriter) will meet to negotiate a deal. The deal will encompass the amount of money the company will raise, type of securities issued, and all details of the underwriting process. There are three ways to structure the deal: firm commitment, best efforts, or syndicate. In a firm commitment deal, underwriters act as a dealer and are responsible for any unsold inventory. The dealer profits from the spread between the purchase price and the public offering prices. In a best efforts agreement, the underwriter agrees to use all efforts to sell as much of an issue as possible to the public. The underwriter can purchase only the amount required to fulfill its client’s demand. If the underwriter is unable to sell all securities, it is not responsible for any unsold inventory. If the investment bank is hesitant to shoulder all the risk of an offering they will form a syndicate of underwriters. One underwriter leads the syndicate and the others sell a part of the issue.
Once all sides agree to a deal, the investment bank puts together a registration statement to be filed with the SEC. This document contains information about the offering as well as company info such as financial statements, management background, any legal problems, where the money is to be used and insider holdings. The SEC then requires a cooling off period, in which they investigate and make sure all material information has been disclosed. Once the SEC approves the offering, a date (the effective date) is set when the stock will be offered to the public.
During the cooling off period the underwriter puts together what is known as the red herring. This is an initial prospectus containing all the information about the company except for the offer price and the effective date, which aren't known at that time. With the red herring in hand, the underwriter and company attempt to hype and build up interest for the issue. They go on a road show - also known as the "dog and pony show" - where the big institutional investors are courted.
As the effective date approaches, the underwriter and company sit down and decide on the price. This isn't an easy decision: it depends on the company, the success of the road show and, most importantly, current market conditions. Of course, it's in both parties' interest to get as much as possible. Finally, the securities are sold on the stock market and the money is collected from investors.
Recommendation
Starting the Initial Public Offering process is a sound business strategy. An IPO will allow the company to tap a wide pool of stock market investors to provide it with large volumes of capital for future growth. The company is never required to repay the capital, but instead the new shareholders have a right to future profits distributed by the company. The existing shareholders will see their shareholdings diluted as a proportion of the company's shares. However, the hope is that the capital investment will make their shareholdings more valuable in absolute terms. In addition, once a company is listed, it will be able to issue further shares via a rights issue, thereby again providing itself with capital for expansion without incurring any debt. This regular ability to raise large amounts of capital from the general market, rather than having to seek and negotiate with individual investors, is a key incentive for many companies seeking to list.
Joshua González
John Sluka
BU628 Strategic Finance
November 11, 2007
Works Cited
Arkebauer, James B. Going Public: Everything You Need to Know to Take Your Company Public, Including Internet Direct Public Offerings. Dearborn Financial Pub, 1998. 11 November 2007.
BU602 StrategicFinance IPO
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