The C-Brief: How to Start an IPO

If your startup aims to expand into new markets, introduce new products, broaden its shareholder base or cash out early investors, you may be considering taking it public. Preparing for an initial public offering — selling shares to the public for the first time — takes careful thought and planning.

Many high-growth companies have been waiting a few years longer to go public recently as they enjoy greater access to late-stage funding from institutional investors, venture capitalists and other private sources, said Nichole Walker, a senior wealth planner at City National Bank.

As a result, she said, companies often find they can grow and add products while remaining private.

Eventually, though, many startup leaders turn to IPOs to fuel growth and provide a liquidity event for early investors and key employees. Beyond providing a large cash infusion, an IPO can become part of a company's branding initiative as it moves beyond the exclusive world of accredited private investors and opens itself to mom-and-pop retail shareholders, she said.

“While there are many benefits to going public," she said, "a company should be cognizant of the costs and obligations associated with enhanced public scrutiny, ongoing disclosure of financial information and compliance with regulatory authorities."

Preparation for this type of event is both extensive and critical and can cost millions. Eighty-three percent of CFOs plan to spend more than $1 million on one-time costs associated with an IPO, not including underwriting fees, which average another $4.2 million plus 4 to 7 percent gross proceeds, according to a PwC survey. If you're considering an IPO, you need to take several steps to fully evaluate your prospects and plan your financial moves.

Once your board has decided to go the IPO route, Walker explained, you'll need to assemble your team — securities attorneys, underwriters and accountants — who will guide you through the process.

 

Time the Market

The entire IPO process can take six to 12 months or longer, depending on the broader environment, according to Walker. A recession, weak IPO climate or tepid stock market may be a reason to delay.

Market conditions go a long way toward determining whether it's an ideal time for a company to go through an IPO.

 

Draft the Prospectus and Other Legally Required Documents

The legal team you hire to manage your IPO will help you navigate the process, including drafting a prospectus, which is a document providing details about your stock offering, company leadership and operations. They'll also file your registration statement (Form S-1) with the Securities and Exchange Commission.

The SEC staff will review for key disclosures and accounting standards and must authorize the public offering before your company can sell shares.

Work with your legal, accounting and underwriting team to stay in compliance with securities laws surrounding the IPO, such as the so-called quiet period, which lasts from the time a company files its registration statement until the SEC staff declares the statement "effective."

Any public disclosures about your IPO plans must be coordinated by your team in order to ensure that no one — including company insiders and early stage investors — receives preferential treatment during the process, Walker noted.

 

Prepare Financial Statements

Your CPAs will handle and verify your company's financial data, a vital role given the importance of obtaining a reliable valuation, providing a clear picture of the firm's condition and filing accurate reports and audited financials with regulators.

Once your company embarks on an IPO, you must comply with strict record-keeping and reporting requirements that you may not have encountered as a private enterprise, such as those mandated by federal law, specifically the Sarbanes-Oxley Act, Walker noted.

 

Secure an Underwriter Arrangement

You will need an underwriter — typically one or more investment banks — to manage the IPO process and create an investor market for your shares.

Working with the rest of your professional team, the underwriters also conduct due diligence on your firm, its leaders and its financials, while ensuring there are no legal problems that could derail the IPO process.

Your investment banker also helps determine the right price and number of shares to offer. In practical terms, this means your investment banker will help you determine how much money your company should raise in the public markets.

You may choose one of several types of arrangements with your underwriter, Walker noted:

• In a "firm commitment," the investment bank agrees to purchase the entire offering directly from the company and resell the shares to the public, making a profit on the spread between the buy and sell prices. This arrangement involves the highest underwriting cost "because that's a huge risk" for the underwriter, said Walker.
• As the name suggests, the underwriter in a "best efforts" engagement promises its best effort to help your company sell shares through the IPO but doesn't guarantee your firm will raise the targeted amount.
• As a subset of a “best efforts" arrangement, an “all or none" underwriting occurs when the issuing company seeks to receive the proceeds from the sale of all of the shares. The proceeds from the issue will be held in escrow until all the shares are sold. If all of the shares are sold, the proceeds are released to the issuer. If all of the shares are not sold, the issue is canceled and the investors' funds are returned.

You may also hire a lead underwriter to assemble and coordinate a "syndicate," a group of investment banks to handle the IPO, which spreads the risk among several institutions.

 

Attract Investors Through Road Shows

For a company getting ready for an IPO, strong investor relations are crucial to both attracting and retaining investors. That's why it's important for your firm to do an investor "road show" to drum up interest for your IPO.

Underwriters often arrange road shows, which can take four to six weeks. They involve introducing your company and its senior management to groups of institutional investors. You'll need to work with your team to thoroughly prepare for the road show, a key factor in a successful IPO.

An attorney that specializes in this type of work can connect you to investors who have funded similar deals, and to investor relation firms that can get your offering in front of banks and the media.

 

Consider Alternatives

If you're running a high-growth company but don't think you're ready for an IPO it's still important to consider your long-term objectives.

“Think about your exit strategy early in the life cycle of your business," Walker recommended.

IPOs aren't the only option for generating cash. And with the cost and complexity involved in an IPO, companies should seriously explore all the alternatives, she said. "Really think about why you want to have an IPO."

For instance, there's an option called a direct public offering, or DPO. This involves the startup bypassing the investment bank and selling its shares directly to the market. Benefits include avoiding underwriting fees and the post-IPO "lockup" period, which can be as long as 180 days, during which insiders can't sell their shares.

Unlike an IPO, a DPO doesn't involve a set price for the shares, which sell for "whatever the market demand is for that particular stock — it can be higher or it can be lower than what the company thought," said Walker, noting that Spotify and Slack both conducted DPOs recently.

The default to market pricing can make DPOs riskier than IPOs, however, an article from Zacks research noted.

Mergers and acquisitions represent additional popular exits for private companies. In fact, IPOs in the United States dropped significantly after the 2000 tech bubble burst, as venture capitalists turned to a "build to sell" model in which they sell portfolio companies to bigger players in the same sector.

Meanwhile, secondary market platforms such as Nasdaq Private Market (formerly SecondMarket Solutions) and SharesPost allow investors to trade private growth companies' securities, providing liquidity for shareholders, Walker noted.

Nasdaq Private Market notes on its website that it formed to provide companies "alternative liquidity solutions while remaining private," and asserts that companies "choosing to stay private longer is not a temporary trend but today's new reality and a new market standard."

Such platforms have served a number of high-profile tech firms that since have gone public, Walker noted.

For entrepreneurs considering an IPO, it's worthwhile to discuss this with a team of professionals in as far advance as possible to formulate a plan for making this a viable route for your company.

City National's wealth planners can provides guidance throughout the entire IPO process.