Initial Public Offerings

One of the most promising new ventures is ACE-Net, a collaborative effort of the U.S. Securities and Exchange Commission, state securities regulators, the North American Securities Administrators Association and the U.S. Small Business Administration's Office of Advocacy. It evolved out of the recommendations of the delegates to the 1995 White House Conference on Small Business to improve capital formation and regulatory climate for small businesses. Companies seeking investments in the range of $250,000 to $5 million can participate. It is an internet-based, nonprofit listing service for securities offerings of small, growing companies located throughout the nation. Applicants are viewed anonymously by accredited investors. To qualify, the entrepreneur must be in a position to sell security interest in their company under federal securities law and corresponding state securities laws. Additionally, ACE-Net provides mentoring and assistance in developing the business.

Initial public offerings (IPO) are often considered to be the ultimate goal for any entrepreneurial venture. Is an IPO really the right goal for your venture, however? All the hoopla about the quick riches which may or my not be gained masks some serious implications for the future direction of your business. Let's take a look at what an IPO means in reality and how you can evaluate whether it is the right step for you.

An IPO is offering stock to the public on an open market for the first time. Consequently, the alternate term for this process is "going public". The first recorded IPO was in July 1791 when equity in the Bank of the United States was first offered for sale. Wild speculation occurred with many heralding this move as evidence of the economic opportunity in the United States, while others expressed horror at the "get rich" mentality of the investors who were looking for an easy way to money rather than following a path of hard work for their money. The Insurance Company of North America followed shortly thereafter in offering shares to the public. During the 19th century, government bonds were introduced to raise funds for war efforts. The turnpike, canal and railroad companies were also financed through the issuance of stocks and bonds. However, it was not until this century that offering stock to the public became a common form of financing a new business and only recently have IPOs become the glamour business that they now are.

Usually an IPO is part of a business' financing strategy. A well-planned and executed business startup will have specific goals for growth and revenue accompanied by financing needs and options to achieve each step of the path. The typical pattern is to start the business with an initial investment from your own pocket, friends and family, supplemented by loans. Then, when an actual product exists, find an angel or venture capital firm to invest in getting the company growing at a rate that will justify an IPO. The rule of thumb for being ready to IPO is that you are growing, you have a definite need for much larger funding, you have a good story, and this is a good time in the market for your type of company. Each industry has different criteria for growth and revenue in going public; therefore, it is important to research publicly traded companies of similar size in your industry to see how much revenue they were making when they went public. As an example, software companies usually need to be earning at least $20 million in revenues to go public.

Should your business IPO?

One of the most important factors considered in deciding whether a company is ready to IPO is its growth rate. The company should not only have three years history that shows growth, but growth at an accelerating rate. Usual growth rates considered optimal are 40 percent for technology companies and 20-30 percent for manufacturing and service. The "ideal" is considered to be what bankers call "40/40": 40 percent growth rate and 40 percent rate of return. Few companies are this dynamic, but potential growth and revenue are critical to how a company will be valued and how much money can be raised by an IPO.

If you have a winner, why wouldn't you IPO? For a starter, look at the loss of control you experience. Many companies refuse to go public for this very reason. All of a sudden you are accountable to a large number of outside investors, all wanting to see gains from their investment. Wall Street becomes a factor in your life. If they don't like the way your company is being run, your stock price may suffer. Your board of directors may not think you are running the company appropriately and you may find yourself out of a job - in the business you created! You are not just accountable to your investors and your board, however. You must also meet stringent requirements from the Securities and Exchange Commission (SEC), including regular reporting. Most businesses find after they go public that they need to assign at the minimum one full time person just to handle reporting requirements. Additionally, the costs of going public can be very steep in both the short and long run. Costs included are a larger financial staff, external accounting fees for required audits, staff to create material for shareholders, lawyers, bankers, underwriters and brokers whose fees are often in the high six figures.

Factors against an IPO:

  • Loss of Control
  • Regulations
  • Reporting Requirements
  • Cost

Is it worth taking the risk that your IPO will be a winner? Of course. For a start, going public is a way to raise large sums of capital that would be impossible to obtain any other way. It presents you, as the business owner, with access to personal wealth because stock in a public company usually trades at a much higher value than shares in a privately held company. It also gives your company a market-driven valuation which can be used for acquisitions, mergers and licensing agreements. For many, there is a sense of legitimacy for their customers, employees, suppliers and competitors.

Factors for an IPO:

  • Gain in equity capital with no interest or debt repayment
  • Allows the company to grow and further develop
  • Solid financial base on which to build
  • Legitimacy
  • Market-driven Valuation

Do note that only .001 percent of all businesses in the U.S. are publicly traded. Part of that is due to the complexity of the process and part because they prefer to be privately held. So if you do decide not to go the IPO route, know that the majority of all businesses have also made that choice.

If you do decide to go public, you have a choice of following the traditional route using an investment banker to help shepherd you through the process or of "doing it yourself" through what is called a direct IPO. The difference is that in a regular IPO you have a team of experts who guide you through the process and your stock is traded on one of the regular stock exchanges. In a direct IPO, you manage all the details and your stock is sold through open markets, not on an exchange. There are internet services available for listing your stock, but the time commitment for the business owner is substantially higher in the direct IPO.

Managing an IPO

Putting together an IPO is not a task for the meek. Most experts estimate that it takes at least one year of intense work above and beyond the day-to-day running of your business. Some of the basic steps needed to prepare for an IPO are:

Complete Business Plan

A detailed (40 to 60 pages) document supporting the corporate profile. Fully disclose all aspects of the business including debt, the use of proceeds, critical processes, and any other factor that may be important in the success of the business. It is important to show that you have considered a wide variety of factors and have a plan of how to deal with them.

Corporate Profile

Two to four page document describing a company's financials, business, principals, their backgrounds, and a description of the market for their product or service. The corporate profile is presented to potential underwriters (investment bankers) to interest them in participating in the IPO.

Economic Analysis

Information for potential investors on the economic viability of your business. Absolute necessities are rate of growth and net profit margins. Other financial ratio analysis and market analysis are useful.

Financial Reporting

Quarterly, audited financial statements for the past three years must be prepared by a professional, accredited accounting firm.

Management Team

An organizational chart with key players that have strong background and experience that fit with your projected plans.


The IPO process is costly and it can't all be financed by the IPO itself. In addition to internal staff needed to prepare the IPO, there are the external audits, legal and investment banker's fees. The rule-of-thumb is to plan on spending at least $100,000.


A good investment banker is critical for your IPO. They draft your prospectus, assist with the filing, solicit investors, determine the offering price and sell the stock. Their compensation is usually a percentage of the offering plus options on buying a certain number of shares of stock in the future. Conduct due diligence on a number of firms to assess which one is the right one for your particular business. Underwriters usually specialize in different types of businesses or industries and finding the right match for you makes the whole process smoother and more profitable.

The first step in the formal IPO process is for the company to register with the Securities and Exchange Commission (SEC). Plan on it taking at least six to eight weeks to prepare all the documentation. To start the process an "all-hands" meeting is scheduled to determine an appropriate timetable and responsibilities for each member of the team. Included are all of the members of the internal IPO team the accountant, law firm and lead investment bank. One of the most critical documents that needs to be developed by this group is the prospectus. The prospectus is a brochure that is used to describe all aspects of the company - its financial data for the past five years, the management team, the target market, competitors and growth strategy. Since the SEC imposes a quiet period of 25 days between the time you file with them until the stock starts trading, this brochure is all that you can tell prospective investors about yourself so its accuracy and informativeness is a vital part of the IPO. Prospectuses for all U.S. companies are available free from the SEC web site or from the company itself.

Knowing that the quiet period will be occurring, the six to eight week period also includes a multi-city tour, known as the "road show". For a number of weeks the company management goes to a new city every day to meet with prospective investors to present their business plan. Common stops are Boston, Chicago, Los Angeles, New York, San Francisco, and Washington, D.C. with others added that seen appropriate to the business. For internationally placed firms, London and Hong Kong are additional "must" stops. The goal of this tour is to get institutional investors excited enough about the offering to interest them in purchasing a stake. Staging the road show is one of the places your investment banker earns his money. Their sponsorship brings the institutional investors and big money investors in to view the presentations.

Following the road show and the preparation of the prospectus, the management team and the investment banker choose the offering price and size of the offering, based on the expected demand for the stock and market conditions. The price needs to be chosen to provide sufficient funding for the business, yet give investors a sense that there will be reasonable appreciation on their investment. Investors expect to receive at least a 15 percent immediate appreciation on their initial investment.

An IPO is declared effective at least two days after potential investors receive the final prospectus and the offering price is set. This happens after the market closes for the day with trading commencing the following morning. The lead underwriter is responsible for ensuring smooth trading of the stock during the initial few days. They can legally support the price of the stock by buying shares of the stock themselves or by selling them short. They can also impose penalty bids on investors selling shares right after buying them. A company's IPO is considered completed seven days after it officially goes public.

Managing a Direct IPO

Offering an IPO directly to the public became possible in 1982 when the Securities and Exchange Commission (SEC) ruled that small companies could raise up to $1 million in a 12-month period given that they had registered the offer under the securities laws of every state in which they planned to sell stock. With every state having different regulations and forms this was still an onerous burden for a business until 1989 when a 50 question uniform form started being adopted by many of the states. This form allows a business to prepare its own prospectus, eliminating the investment banker from the equation. Costs for a direct IPO average about $30,000, substantially lower than for an IPO run by an underwriter.

To raise capital under a direct IPO, your business will need to file a Small Corporate Offering Registration (SCOR). Stock sold under a SCOR can be traded in established secondary markets making the investments more liquid for potential investors. SCOR has a standardized state filing form, Form U7, a 50 question disclosure document that is similar to a business plan. While external review is not an absolute necessity for this process, having the document reviewed by an attorney and an accountant are a wise course of action. Audited financial statements are not required for offerings under $500,000, but again are wise to have as an attraction to investors. Registration takes about 30 days after filing. The U7 is filed with your state, not the SEC. The SEC requirement is a Form D filed under Rule 504.

This is simpler than it used to be? Definitely. take a look at what the process is for an underwritten IPO to understand the complexity of going public on one of the major stock exchanges. It would be wise to review that process anyway to understand the broader ramifications of going public. Much of the documentation on going public with an underwriter is also useful to the process of managing the IPO yourself.

One of the most difficult parts of a direct IPO is finding investors. Not only are the shares not traded on a traditional exchange, they are also less liquid making potential investors more wary. There are a number of online sites that provide a listing service for direct IPO's. Among the best known are: Direct Stock Market and Direct Hit. Many of these sites specialize in particular types of businesses so explore to see which are the best match for you. Each will also have a fee for listing so be aware of the guarantees, market reach and regulations before making the decision to list with a particular service. If you have a specialized product of interest to a particular audience, it may be as productive to find forums specific to your business to advertise your stock offering. The important factor is to establish visibility to potential investors.

Selling stock in your business through a direct IPO has been likened to selling your house without a real estate agent. It can be done at substantial savings, but marketing is much more challenging. There is a risk that no money will be raised at all in spite of a considerable amount of work on your part. It is estimated that about one in three direct IPOs are successful. You can be one of those successes. Just take one step at a time and complete it thoroughly if this seems to be the right path for your business.