Thursday, January 1, 2015

Are you REALLY ready to go public? A hopefully helpful guide to some key questions

2014 is in the books. It’s been a pretty terrific year in the IPO market. According to Renaissance Capital, through December 15, there have been 271 IPOs in the US this year, as compared to 221 IPOs a year ago at this time, a volume increase of 23%.  Thanks to Alibaba’s thunderlizard of a deal, the dollars raised by IPOs this year $ 84.2 billion exceeds last year’s total of $ 54.6 billion, by 54%%.  Not bad

Ah, but look deeper and you will see that actually, roses weren’t coming up everywhere. While 271 IPOs have been completed so far this year, conservative estimates suggest that more than 350 companies filed S-1s, a difference of nearly 30%.  For every 3 deals that filed and went public this year, at least one did the training, filed an S-1 and didn’t make it to the starting line.

Of course, we need to back out those companies that filed late in the year, targeting a 2015 transaction.  If we aggressively estimate that 20 fit that pattern, we still have more than 50 that didn’t get the job done as planned. When you consider the time and expense required for an initial filing, that is a big number.

What’s the difference and what price “Optionality”?

Bankers and others can be convincing when suggesting companies take advantage of the relatively new option to file confidentially: “Get on file now, then choose your timing later, but you’ll be ready.”  Factually correct? Yes. Good for your business, your P&L, your employees or your IPO?  Not so fast.  Preparing for an IPO too soon is neither a cost nor risk free option.

The on-going and elevated expense, distraction, loss of momentum and sometimes embarrassment (Box anyone?) that accompany a premature “go” decision can easily outweigh any timing flexibility benefits.  Picture the horses as they are led into the starting gate on Derby Day.  There is a reason they don’t load them until seconds before the bell.

OK, but IPOs do take a long time. How do we know when to start?

At January board meetings, following the “year in review” appraisals, many private company boards will have the “Is this the year to go?” conversation.  By “go”, we don’t mean begin internal preparations.  “Go” means schedule a bakeoff and hire bankers.  In advance of those meetings, we offer 5 questions every board should ponder before dropping the green flag.

1.     Can your sales and financial teams accurately forecast results for the next few quarters? Did you nail your forecasts last quarter?  If answering either of these is anything other than a rock solid “yes”, then take your time. Public investors show no mercy to companies that miss an early quarter.  Once you are in that doghouse, it’s a long slow climb out. Worse still, the brickbats that will come your way courtesy of angry investors are mere annoyances relative to the grenades your employees, customers and partners may lob through your door if you miss an early public quarter.  A swan-diving stock disappoints, creates instability and begs questions about  management’s reliability. It just takes one miss.

2.     Do you have the right team in place?  No really, are you sure you have the right team in place, not just for the IPO but also for the long term?  Step back and take a cold clear look.  The team that helped you get this far may be gifted, battle-tested and may be composed of friends. That doesn’t mean it’s the team for a fast-growing public company.   Public investors want to know that the C-suite in place for the IPO can scale the organization.  Newly public companies juggle enough knives when adjusting to the market’s spotlight.  There’s little bandwidth for concurrently integrating new senior leaders.  Save, time money and aggravation; line up the ducks before, not during, the process.

3.     Is your business model stable and ready for public scrutiny?  Admittedly, there companies (ex. Twitter) where even 12 months post-IPO the model remains an enigma. We grant that if your business has north of 200m active users, investors may cut you some slack.  However, for most, a more stable model correlates to a larger crowd of investors rallying around your IPO’s order book.   Are you hoping to migrate to a subscription model? Do you see significant price changes or regulatory updates on the near term horizon? Launch that new model or absorb the changes before you step on the IPO court.  In the eyes of investors, a foot-fault of your own making or because someone else moved the lines in a way you could have predicted, will cripple your stock’s performance and likely your personal reputation for a very long time.

4.     Are you ready for an intense audit?  There isn’t even a close second. The reason most companies on the IPO trail get thrown off course is because their audits aren’t ready on schedule. Audits won’t be rushed. The drill down scrutiny on every last decimal point is much more intense when your auditors know you’re preparing for an IPO.  We recently ran into IPO/ technical-accounting expert Barrett Daniels, Managing Partner of Nextstep Advisory.  He put it this way:

The reason an IPO audit takes longer than a typical private company audit is the dramatic increase in the risk profile. I assure you the audit partners want the audit to go quickly but they are, and rightfully so, going to take extra precautions to ensure the work is performed to endure the utmost scrutiny from the company, bankers, and ultimately the SEC.  The size of your audit team and number of questions will often triple during this process making for a robust and challenging process. 

5.     Is your company really strong enough to support the valuation you expect?  For this point, we will excuse readers at health-science companies, but for those selling products and services, not hopes and cures, size matters.   

a.     IPOs are expensive.  Bankers, lawyers, accountants, infrastructure and other service fees add up.  While most costs tied directly to the process are “one time”, other expenses including filings, higher legal and accounting bills and investor relations costs will be an on-going reality.  If the business isn’t able to comfortably absorb those charges, it isn’t ready to be public.

b.     Management teams tend to be optimistic. Bankers, reflecting experience, tend to be conservative.  Your finance team may produce a model projecting revenues over the next two years of $X and $Y. By the time bankers have helped you “refine” them, your forecasts (for the sell side analysts) will likely be closer $.7X and $.8Y. Expect similar treatment (opposite direction) for your expense projections.   It is those banker-adjusted numbers from which your initial valuation range will be determined.  Do the exercise in-house to be sure the projected valuation, based off a hacked-up model, will be acceptable before hiring banks and kicking off a process.  The more directly you face the conservative forecast reality, the better prepared you will be for the go/no go decision.

Companies need not score a perfect 5 to launch, but assessing answers to the hard questions upfront can profoundly improve the timing and reduce the costs of the IPO process.   Done right, an IPO can be a smooth, dare we say fun, stepping-stone to success.  A solid public launch not only enhances the corporate treasury but also an entity’s reputation, brand awareness, flexibility, competitive position and quite possibly, the rate of growth. 
The key, to paraphrase Kenny Rogers’ hit from yesteryear, “The Gambler”, is this:

“If your going to play the game folks, you gotta learn to play it right.”