In some cases of venture companies, becoming publicly owned and traded on the stock market is better for a company than undergoing a private acquisition. In these cases, the company has an initial public offering (IPO), when it sells stock publicly for the first time.
Exits are important to investors because, without an exit, they don’t make money. Sure, you’ve got a plan that will generate a lot of profit, but that profit doesn’t get to the investor. Unless you have a revenue-sharing or dividend agreement, the money that your company makes as it grows stays with the company.
The VC is working hard to help you, making connections, attending board meetings, and risking his portfolio and reputation on your success, but he doesn’t make a penny until the exit.
Qualifying for an IPO
To be qualified to have an IPO, your company needs to achieve several benchmarks that differ, depending on the exchange you want to be listed on. When you seek an IPO, the general assumption is that your company has grown to the point where its ongoing earnings are relatively predictable. Examples of earnings benchmarks required to be listed on public exchanges include the following:
NYSE: $10 million in pre-tax earnings over the past ten years with $2 million minimum profit in each of the past two years
NASDAQ Global Select Market: $11 million in pre-tax earnings over the past three years and $2.2 million minimum in each of the past two years
NASDAQ Global Market: $1 million or more in pre-tax earnings in the most recent year or two of the past three years
NASDAQ Capital Market: $750,000 or more in pre-tax earnings in the most recent year or two of the past three years
AMEX (American Stock Exchange): $750,000 or more in pre-tax earnings in the most recent year or two of the past three years
Some other measures that the exchanges require may include some combination of net tangible assets, market value of publicly held stock, number of shares that are held by the public, number of public board lot holders, trading price of listed securities, and total shareholder equity.
Benefits of an IPO
For some companies, an IPO is the best strategy and offers a variety of benefits:
It opens up your company to a huge audience of potential investors who are interested in investing in public companies because the shares are much more easily sold and can be traded on public markets.
Investors trading in the public market can invest $50,000 on one day, for example, and pull the money back out the next day, next week, next month or whenever. That flexibility is attractive to a lot of investors.
Capital raised on public markets is typically raised at lower costs than for private equity. Being public also opens up opportunities for non-equity financing at relatively lower interest rates than private companies may pay. Earnings multiples are higher than for private companies, often by as much as 35 percent.
A lot of publicity and prestige comes with being a public company, which can accelerate your growth. Customers may have higher awareness and confidence in the stability of a public company.
Access to public markets provides a strategic advantage if you are pursuing an acquisition strategy to rapidly grow a market. As a publicly traded company, you can use liquid, easily valued stock for acquisitions rather than having to use cash. You may also use stock for executive compensation to attract the best and brightest in your field.
Deciding whether to pursue an IPO
Going public is not for the faint of heart. First, there’s the expense. The process itself is expensive, costing millions of dollars:
You need to pay 7 to 10 percent of every dollar raised to the underwriters who sell your stock. If you value your stock too low, you can leave millions of dollars on the table, and if you value your stock too high, your offering can be a flop with nobody buying your stock.
You need to add staff for investor relations, internal legal counsel, compliance, and more.
You’ll be working with (and paying) an underwriter to prepare the marketing materials and plans for your road show in which you pitch your company to investors.
And after all of these expenses, you’re not guaranteed that your IPO will be a success and you may not raise the money you need.
Second, to prepare for a public offering, your company will need to be scrubbed clean and formally audited by one of the major CPA firms. Prior to going public, you need to update your processes to be in compliance with all of the regulations that the Securities Exchange Commission (SEC) has, a task that can take a year or more and cost hundreds of thousands of dollars.
Last, as a public company, your financial information and much of your strategy will become public and available to your competitors. In short, you need to have a really good reason to pursue the IPO strategy over other options. Companies that pursue an IPO too early can collapse under all the regulatory requirements.