Public Exposure
Is it worth taking your business public when the economy is down?
By Sheryl Nance-Nash
Not so long ago, companies were tripping over themselves to get to the head of the IPO line. These days, only the brave dare step up.
“The IPO market is deplorable, even non-existent. I’ve been in practice nearly 30 years and I’ve never seen anything remotely comparable,” says Thomas Murphy, partner-in-charge of the Chicago corporate practice at the law firm of McDermott Will & Emery.
The numbers aren’t pretty. Globally, only six companies were able to raise more than $100 million in the fourth quarter of 2008, down 97 percent year-over-year, says Frederick Lipman, author of International and US IPO Planning: A Business Strategy Guide.
In the United States, more than 100 companies withdrew or cancelled their plans to go public, adds Stephen Ferrara, a partner with BDO Seidman in Chicago. Total US IPO proceeds were approximately $30 billion in 2008, a 50-percent drop from 2007. Much of that money included the $18 billion from Visa, which was the largest US IPO in history.
“If you exclude Visa, it was the worst IPO market since 1990,” says Ferrara.
Many of those who ventured into IPO waters nearly drowned. “The average return on IPOs in 2008 was negative 32 percent,” Ferrara adds.
“Poor economies or strong economies are not the problem with markets—uncertainty is. Stock analysts and investors love stability, not uncertainty,” says Mark Lundquist, cofounder of SellMyBusiness.com, an online resource for finding business, real estate and equipment for sale or lease.
That uncertainty, plus the costs and complexities of Sarbanes-Oxley, have really hurt the public market, says Lundquist. Nobody expects a major turnaround any time soon.
“Based on recent economic reports, we will be lucky if the economy picks up this year. Maybe the fourth quarter will bring an uptick in IPO activity. But in reality, it may be 2010 before we see market conditions show some real improvement. Because we’re in unprecedented economic times, no one really knows what the future holds at this point,” says Ferrara.
Companies that are in declining industries, including retail, financial services and real estate, likely aren’t good candidates for an IPO in the near future, he adds. Who else should think twice? “Companies that need 5 years before reaching positive cash flows or any appreciable revenue, and possibly even energy-related products, unless there are some huge government incentives,” says Lundquist.
Rather than selling equity in the public markets, companies might look at alternative ways to raise capital. For example, in late 2008, Chicago firm Entrex announced that it was institutionalizing an alternative new security structure known as “TIGRcubs™” (Top-line Income Generation Rights Certificates) for private and public companies. This security structure represents a fixed ownership interest in an issuer’s GAAP gross revenues, in consideration for a lump sum infusion of cash. This in turn provides investors with current income and avoids dependence on liquidity events as the sole source of investor returns. It‘s ideally suited for companies with annual revenues of between $5 million and $250 million.
“TIGRcubs™ is an alternative security to equity and mezzanine financing for companies to use, and is attractive to investors because of its pricing and current income features” explains Entrex CEO Stephen Watkins.
Chief among the advantages for an issuer is the fact that there is no equity dilution, which means that ownership percentages are retained. For investors, the advantage is that cash distributions are provided monthly and, unlike equity investments, returns are not dependent on liquidity events or market timing.
“It’s a radical change that reverts back to the original and fundamental methods of the regional security exchanges that were so successful where there was transparency,” says Watkins.
Even with the risk, doom and gloom, going public still might be a savvy strategy for some. Two factors are making going public attractive now. “First, the SEC changed its rules just before the holidays, making it easier to conduct an IPO. The SEC recognizes that if banks and private lenders can’t provide the capital for companies to grow, it’s best to allow more companies to raise capital via shareholders,” says Lundquist.
“Second, hedge funds and some investment banks have decided to take matters into their own hands, away from Wall Street, and are now aggressively seeking appropriate companies to invest in. Some investment banks that normally shied away from pre-review or early-stage companies now see that these opportunities may provide better returns than the Standard & Poor’s,” he explains.
“It may be a good time, too, for companies with proven business models in mature industries that are generating significant cash and returns, that have a fast return on cash, but are looking to transition the business,” says Roger Hardy, CEO of Coastal Contacts, an online vision-care supplier based in Vancouver, Canada.
If a company is already a household name, with great growth plans and a compelling reason for the money, then public may be an option, says Murphy. Companies that haven’t been so adversely impacted by the recession, such as healthcare businesses, energy and defense, also may make good candidates. What’s more, some companies will stand to benefit from the economic stimulus package. For those fortunate businesses, the timing might be right for an IPO. There isn’t likely to be a crowd of companies hankering for the spotlight. They’ll get their 15 minutes and hopefully more.
So if the odds are in your favor, here’s what you need to consider.
For starters, be clear about your objectives. “CEOs have to look hard at the IPO journey. Besides the often underestimated cost and resource implications to reach and maintain public status, you have to consider what being on the open market offers you in terms of support for ongoing share price. With stock prices so depressed, it’s hard to say where a company might price or what it can sustain for shareholders beyond that. If remaining as, or becoming, a public company doesn’t provide efficient access to capital (at a reasonable cost), along with shareholder liquidity, then what’s the value of being public?” asks Watkins.
“The IPO process in itself is not the end all and be all that it’s chalked up to be. An IPO is not a kind of accomplishment of status, as it was once thought to be; it’s an activity that takes a tremendous amount of attention and resources, has its associated risks, and needs to be considered in relation to its benefits. It’s an extraordinary commitment, actually, and if alternatives to raising capital at less cost are available then they should be seriously considered,” he explains.
Secondly, be willing to complete your transaction at a lower price. Think conservatively, says Murphy.
“Don’t rush. Spend more time than usual planning and preparing for the offering. Don’t hurry to market to meet a window. Even if a window opens in this market, over-prepare and over-plan, because it will be hard to extrapolate from previous markets, since there’s no real comparison,” he explains.
Slowing down will keep you grounded in those things that are important, such as researching the investment bank behind the IPO. “Gain an understanding of the strengths and weaknesses of the partner they are working with, including the bank’s success rate in completing IPOs, the bank’s knowledge of your industry, its track record in getting the price promised to the target company and for supporting the company in markets post-IPO,” explains Ferrara.
Most importantly, ask yourself, “Will the IPO help my company in the future when seeking financing, acquiring businesses and recruiting/retaining talent?” and “Are we ready for the microscope?” You’ll be measured quarter to quarter, and senior management will be required to disclose personal compensation and benefit information. There will be less flexibility in managing your business, since you’ll be required to report to an independent board. And you’ll need to guarantee the appropriate internal corporate structure to support a public company’s reporting requirements.
If after a good, long look the answer is decidedly a go, know that success is possible in any market, even this one. Says Ferrara, “The top performing IPOs in 2008 were all niche businesses that had a distinct market for their products. They returned approximately 30 percent on average.”
Not so bad after all, perhaps.