They're baaack. With the strong stock market performance of the first six months of 2013 (+15%) and with the swing to positive inflows to active equity funds, rather than out, investors have clearly signaled that once again, their interest lies on the denominator side of the risk/reward equation.  Not only are equity investments appealing, but also, even those with higher risk profiles including IPOs are again catching investor's fancy. 

On many fronts, that's good news.  Many are cheering the uptick in IPOs, particularly dramatic in the med/tech space, but don’t be fooled, a robust IPO market conjures up both good and bad memories for investors. 

Never forget that it's one thing to "get a company public", but for those who choose that route, the misnamed IPO "exit" is really just an important milestone on the way to building a sustainable business with the opportunity to thrive in the years ahead.  Unfortunately, as we know too well, the majority of IPOs, even some of the most highly anticipated, race out of the gate only to stumble during the first 18 months on the public company track, often failing to regain their footing fast enough to ever realize a fraction of their potential.

With that in mind, and based on years of working closely with institutional investors, in two parts, we offer our guide for newly public management teams to the top 10 things fledgling public issuers should not do. Ever.

10 Ways to go from super steed to dog chow in record time

1.       MISS YOUR NUMBERS:  Miss the numbers in one of the first 2 quarters after IPO and investors will quickly assume that management is incompetent.  Institutions know that bankers urge conservatism on the early quarterly forecasts.  In fact, the rule is "set expectations that you can not miss". Therefore, if you miss that inch-high hurdle, you either didn't listen or don't have a grip on your business, and it's a very long road to recovery and credibility.  Make sure the model you bless with the street is conservative. They are perfectly happy to have you "beat and raise".  If you miss Q1 or Q2 nothing else much matters from an investor's perspective.

2.       Be naive about the ways of Wall Street;  If you beat the analyst’s model but miss their real expectations, and worse, fail to understand that you missed you will again have credibility issues.  Marin Software is one (of many) poster children for this problem.  The company went public with what appeared to be extremely conservative research analyst forecasts.  Unfortunately, its first quarter results narrowly beat those forecasts and worse, showed growth decelerating more rapidly than the street expected. Oops. Management then compounded the error by meeting with top investors, failing to acknowledge the problem, saying they could not understand the selloff as after all, “We beat the analyst’s models!” Double oops. 

Make no mistake, investors will pummel your stock for any miss, but if management owns up to a rookie mistake, the trip back to credibility will likely be much faster.

How to avoid this pothole? Management should clearly communicate the core metrics by which analysts should measure the business performance and from the start, should maintain a dialog with both the buy and sell side to really understand (not to comment on or change, just to understand) street expectations.  In the event of an unexpected deviation from plan, be ready to fully explain the delta and how you hope to avoid a similar surprise in the future.  Most buyside investors will tell you "there's no such thing as a one quarter problem".  The more rapidly management owns up to the realistic magnitude of the hiccup, the quicker investors will rebuild trust. 

3.       Bash your direct competitors:  In big growth markets there should be plenty of room for multiple players. Bashing competitors sends a message that the market may not be as big or fast growing as investors hoped.  Furthermore, a lower competitor valuation is bound to hit your stock as well, so wish them the best.  Explain to investors factually how you are different, preferably in terms of product performance, architecture, and technology.  Explain why you win when you compete, but do not make your success contingent on beating the other guy.   And one more thing, suing your competitor while they are on their roadshow, particularly about some issue that has been in the markets for months, makes your team look scared, wasteful and just a little pathetic.  It also generally makes the buy side laugh as they have seen that movie before.  Tread lightly on your competitors.

4.       Casually dismiss the behemoths:  Pooh-poohing the ability of those big, well-funded technology companies to respond nimbly and competitively, is never a good story.  At least from our observations, it also generally isn't a good business practice, but that's a different column.   Investors like management teams that are wary, respectful and paranoid.  Acknowledge investors' fears that competitors are big and well-funded and cannot be ignored.  Then tell the buyside what you are doing to maintain your lead, how you have built your financial model to leave room to respond if need be and how paranoia drives you.

5.       Sell too fast:  Sorry folks, active management should not sell stock before reporting two clean quarters.  While this is always true, it is even more distressing to the buyside when individuals who sold in or just before the IPO, hit the cashout button again at first opportunity.  Investors identify management selling in an early lock-up release as a major red flag that can trigger institutional selling or give investors pause about building a bigger position or making a long term commitment.  Public investors prefer management 10b-5 plans as a means of monetization.  That said, sometimes individual management members have been patient or are concerns about diversification.  If an individual hasn't sold recently he or she can sell early (again much better if after two strong and clean quarters) without freaking out investors. The key is to sell 10% or less of vested holdings in the early going.

There you have it; part 1 of our thoughts on errors a newly public company should never make, based on conversations with the buyside.  But wait, there's more... part 2 coming soon.

Straight from the Buy Side - Part 1

Sometimes, its good to go straight to the source.....

With the addition of Leslie Pfrang the enormously talented Leslie Pfrang to open the NY office and head up Class V East, over the past few months, we have been meeting with investors and private company management teams both to discuss our expanded products and services and to listen to their thoughts and concerns about the IPO market in 2013.

What we learned should keep this blog going for  - well, at the rate of recent posts - decades.  Hopefully, we will shrink that down to months.

In future posts, we'll share investors' quotes about bookrunner structures, share allocations, preferred lock-up release strategies and how to recover if something runs amuck during the first year as a public company.  For the first "reveal"of what investors are thinking, we're focused on what, if anything, from the syndicate side has any impact on the decisions by those actually making the buy or pass decision on IPOs.  

Perhaps because it was the question that received the most consistent answer from the country's largest IPO buyers,  we're starting with these investors' almost universal belief that in IPOs, the smaller, full-service or boutique banks are under-compensated relative to value provided.  The comments that follow may be our writing, but they are wholly reflective, and in several cases verbatim quotes, from the country's biggest long-only buyers of IPOs.   We addressed our questions specifically to those firms and portfolio mangers that investment bankers call out when building "ideal ownership" target lists for new issues.

By way of background for those who haven't been through the process, when picking bankers "for the cover" of an IPO, the goal is to build a syndicate of banking teams with different skill sets, serving different investor market segments, hoping that when the time comes for the roadshow, issuers can maximize the number and variety of accounts that will hear the story.  That's the theory.  In reality what happens, particularly as the market has come back from the adventure that was the 2008/2009 debacle, is that issuers will choose as bookrunners several big banks that look very much alike in terms of skills and client focus.  Once those two or more big guys have been promised the majority of the total deal fees, the issuer-to-be will parse out what remains to the smaller banking organizations. 

Issuers are acting pragmatically when they choose this structure.  With compressed bonus structures, there is a great deal of movement by bankers and analysts between firms and therefore, many issuers wisely want to have a big cheese and an "insurance big cheese" firm to work actively on the deal, just in case a banker or the key analyst opts out in the middle of the process.  Furthermore, as no one firm has anything close to a monopoly on good ideas, having more smart minds fully engaged in the process improves the output.  The problem is that by the time two or more big banks have been enticed into the deal, the funds left to compensate the rest of the syndicate are sparse.

During the actual IPO process, at least for "hot" companies, this isn't much of a problem. The simple truth is that for the sought-after companies, those offering a compelling investment thesis, a solid financial plan as well as a credible and skilled management team, most any bank with a balance sheet can place an IPO.  For those that are more complicated or speculative, or for those where something goes wrong after trading begins, the importance of a fully committed syndicate, including several high-quality, engaged co-managers, grows rapidly as investors are likely to seek a cross-section of opinions.

However, once the IPO is in the rearview mirror, the image blurs.  Analysts at the large "bulge bracket" banks, are compelled to spend the bulk of their time and effort following the largest market cap companies. Why? Because coverage of large cap stocks drives a research analyst's Institutional Investor (or II) ranking.  Bankers feature these rankings when pitching new IPO business, to demonstrate the superiority of their research team.  Perhaps even more importantly from an analyst's perspective, research directors use this ranking to determine compensation and allocate the bonus pool.   Perversely, according the investors with whom we spoke, high-ranking in II correlates negatively with strength in on-going coverage of smaller market cap, recent IPOs.  This means that if you, the newly issued IPO, have a market cap much below $2.0 billion or a float much below $.75 - $1.0 billion, you just aren't all that important to those analysts.  You are the talented singer at the Bluebird Cafe and their careers are made supporting the acts at the Grand Olde Opry.

However, the smaller firms earn their stripes by discovering and/or promoting those names everyone doesn't already know. As talented as some of the analysts at these firms are, they are unlikely to have an edge on Google or Apple.  However, they do have the flexibility to spend more time on the "up and comers".  It is for that work that the buyside will pay them.  Long after the IPO fireworks have faded, these are the analysts that are more likely to stay with your company, promoting your story when appropriate - if for no other reason than that they have to do so to  differentiate and stay relevant.

But don't take our word for it.  Here is the specific question we asked the major IPO buyers, followed by the verbatim answers from the investors (in no particular order).

Q. On a scale of 1 to 10 how important are some of the smaller (non bulge bracket) investment banks to the health of the technology IPO and on-going research process.

Investor 1. Boutiques add all the value for companies < $ 3 bln. They do all the real research and can give a more balanced view. I think economics should be paid 60 bulge/40 boutiques on the IPO, maybe more to boutiques on the follow on. Bookrunners on the top line get the quality deals because of who they are. The four guys on the bottom line are what make the stock work over time.

or

Investor 2: Co-managers do all the ongoing research, they are not all busy with II like the bulge bracket.  II focus for bulge bracket firms means they have to spend most of their time on large cap names, pushing the small cap stocks off to their juniors. Bulge will do non-deal roadshow and call management. Boutiques will do real proprietary research and have a differentiated view. We think 25 to 35% should go to the boutiques on IPO and more on follow on.

or

Investor 3.  Boutiques are very important to my decision to invest. Economics for boutiques should be much higher than currently, perhaps 30 to 35%.

These are NOT culled responses from a group of diverse answers, and in case anyone is suspect, note the names on the cover have no impact on the work Class V does.  The truth is that 90% of the companies in our survey answered the questions similarly to those quoted above.  Institutional investors definitely value the big banks but also clearly rely on the aftermarket research provided by the relatively smaller firms.  Quite to the contrary of those bemoaning the demise of the famous Four Horsemen (Alex Brown, H&Q, Montgomery Securities and Robertson Stephens), an entire stampede of somewhat smaller full service, regional and boutique firms are very much alive.  However, it is up to management teams and the boards of companies headed down the IPO track, those thinking beyond the bell-ringing ceremony and on to the quarters and years that follow, to make sure those non-bulge bracket organizations are able to fund the costs of on-going proprietary research. The health of the IPO market depends on it.

Next up: - the buyside's thoughts on the age old - How many bookrunners? question.