Why should a company go public? (IPO)
Discussing Initial Public Offerings
Looking at the 9,796 start-ups that were venture-backed between 1992 and 2001, there were 1,331, or about 14 percent, failed outright; 1,902, or 20 percent, were acquired or merged; and 5,706, or 60 percent, are still privately held. Of the latter, some may not be good enough to sell, some are too young, and some are classified as “walking dead,” which means there have not been any returns to the investors and none are really expected any time soon. The balance, 857, or 9 percent, went to initial public offerings (IPOs).
There were 1,919 IPOs recorded for the years 1997 to 2002, of which 756, or 40 percent, were venture-backed. But the economic downturn following the Perfect Storm has affected the number of IPOs. According to Alfred R. Berkeley III, vice chairman of NASDAQ, the “system is broken” as venture capitalists cannot push out any more new companies into the public markets until the system gets fixed. We saw the total number of venture-backed IPOs drop 86 percent—from 257 in 1999 to 37 in 2001. And just between 2000 and 2002, the average offering size fell 18 percent, from $93 million to $76 million. Using the definitions from previous Articles, the Figure below presents a sector-by-sector analysis for venture-backed IPOs.
The IPO Journey
An IPO should not be viewed as an end to the business, but as an important milestone in the entrepreneurial life cycle. Getting to an IPO is often described as the “IPO Journey.” In 2001, the IPO Journey, or the amount of time from initial equity funding to IPO, was longer than it had been in years. The average age of a venture at time of IPO was around fifty-four months, compared to thirty-four months in 1998, and forty-eight months in 1994.
How long does the IPO Journey usually take? We examined in detail, industry by industry, the ages of 1,825 ventures that went public in the years 1997 to 2001. The average was 79 months, or six-and-a-half years. The range goes from 55 months for telecommunications ventures to 94 months for healthcare ventures. The others were: industrial/energy, 92 months; semiconductors and electronics, 90 months; retailing and media, 87 months; computer software, 82 months; computer hardware and services, 78 months; business/financial, 70 months; and biotechnology, 66 months.
To some, eighty months may seem like a long time, but the importance of advance planning for the IPO Journey cannot be stressed enough. In fact, we found that some simple day-to-day management decisions and corporate transactions made years in advance of an IPO can create significant legal problems and the need for “corporate cleanup” and housekeeping later on.
Randy Lunn, general partner at Palomar Ventures based in Southern California, has been involved in more than forty IPOs over the past twenty years. He has invested over $300 million in early stage ventures. He expects each one to be “IPO worthy,” because it will still be attractive for someone to buy if the IPO gets pulled. Plus, as he says, “It sort of leaves a hook out for strategic partners to quickly snap’em up.” Most importantly, it directs the venture team on how to build and successfully guide the growing venture. Quite simply, and to paraphrase Covey, always begin a venture with the IPO Journey in mind.
Advantages of IPOs
In addition to providing a “liquidity event” for the venture team and the investors, IPOs offer many financial advantages. According to a report published by Babson College, 85 percent of the CEOs who led an IPO wanted to raise capital for growth, 65 percent wanted to increase their working capital, 40 percent wanted to facilitate the acquiring of another company, 35 percent wanted to establish a market value for the company, and 35 percent wanted to enhance the company’s ability to raise more capital. There are nonfinancial advantages too. Most importantly, an IPO is the benchmark for the credibility and viability of a young business venture with prospects, customers, and suppliers. It is also a great opportunity to create equity incentives for existing employees and for help in recruiting executives.
Disadvantage of IPOs
The chance of a high-tech venture to become a successful company that goes public is about one in six million. First of all, it is too difficult to time the markets. According to Jay Ritter, a professor at the University of Florida who studies the behavior of IPO markets, “The IPO market is never in equilibrium; it’s always too hot or too cold.”
Second of all, a large amount of management effort, time, and expense is required to comply with SEC regulations and reporting requirements. For example, consider the Sarbanes-Oxley Act of 2002, which was signed into law as a direct response to the deterioration of public confidence in financial governance of prominent public companies. It has tightened boards of directors’ audit committee responsibilities, imposed new CEO and CFO certification requirements, and raised the “standard of care” obligations on management dramatically. In other words, getting the S-1 registration documents through the approval process is taking much longer today than before and during the Perfect Storm.
Third of all, during the IPO process, the venture undergoes a tremendous amount of stress testing. According to one CEO, “There are so many parallel processes going on simultaneously. It takes a strong and well-organized team to get the job done.” In a survey of Inc. magazine’s top 100 firms, the CEOs who had participated in IPOs reported that they spent 33 hours per week for four months on the offering. Also, the cost of raising $5 million averages some $700,000 and involves 900 total hours of the principals’ time to complete an IPO. Those pursuing an IPO will need to do so with a steady pace, not a wild scramble. Basically, it becomes a marathon, not a sprint, although you will need to sprint from time to time to meet deadlines.