To many startups, the Holy Grail will the Initial Public Offering (the “IPO”). The IPO precipitates the significant event where employees can finally sell at a premium their ISO shares, founders can find an able and willing marketplace for their warrants, and the public markets make the determination of the fair value of the company. The big question is how to get there.
IPOs and the legal process are described within the 1933 Securities Act, which covers all issues related to the procedures to issue stock or shares to the public. The law had been promulgated to protect the public from the many trading and stock issuance abuses that led, in part, to the Great Depression. By abiding through the ’33 Act and its rules and regulations, any company can duly register its stock and sell to the public. That process alone will not maximize the value of the stock. How the stock is distributed and who purchases that stock determines the stock price. What does that really mean?
Now I have observed the bottom feeder approach where a company, seeking to distribute shares to the public, finds lawyers and accountants who can file the appropriate S-1 documentation to the SEC and be approved for public trading. However, the SEC registration and approval only provide the permission to sell the stock to the public, not determine its market value. In the movie, “Wolf of Wall Street”, the small brokerage firm had been able to handle the IPO of Madden shoes and sell its stock to its clients. And one can still find many small brokerage firms willing to sell any SEC registered stock as part of its offerings.
The true Holy Grail is to engage the top Wall Street investment banks to manage the IPO. Why? Because those firms brokerage clients represent well-heeled and large institutional investors. And since these are experienced and knowledgeable clients, the company undergoes a more rigorous due diligence process. That process includes employing only the top four accounting firms and any of the top ten Wall Street law firms with IPO experience. The due diligence costs are high, but the results fulfilling.
The Wall Street investment bank coordinates the S-1 registration process with a detailed calendar and milestones. The company’s management team huddles its team to begin to draft the S-1 document, which is a carefully written business plan of the company with audited financials. And every word and statement are carefully vetted for accuracy and legitimate third party sources by the law firm. In other words, if the company claims to provide the leading product in its market, the company must corroborate that information from a well-known third party source. Every period and comma are accounted for. The lawyers will make sure that any potential reader of the document will not be misled by any statement. Also, unlike standard business plans, the company cannot make projections of its sales since any variation of those numbers can lead to potential class action lawsuits by shareholders.
The overall drafting process will take approximately about six weeks with intense meetings virtually every day. (I even received Fedexes Sunday mornings.) Then the two week roadshow begins in which the investment bank prepares the hourly presentations for the CEO to pitch the company to its clients in the U.S. and internationally. In this case, prior to the IPO, the investment bank can gauge the purchasing interest in the company’s shares. In other words, it is very possible that on the day of the IPO virtually all shares are committed to be sold to its many clients.
But before the engagement letter is signed with the investment bank, the bank’s management must have concluded that the stock can be traded on NASDAQ. NASDAQ has certain minimum criteria which any company must meet in order to be traded at the exchange. Rather going to exact details which can be googled or gleaned from www.nasdaq.com, the overall rules mandate that the company needs to be traded at no less than a specific dollar amount ($1.00), have minimum annual revenues, and sufficient capitalization ($1 million). (During the recent Great Recession, NASDAQ had issued an exemption period from being delisted since the market pounded the share values from many legitimate operating companies — from Citibank to Pier 1 – to stock trading values less than $2. That was a unique historical period where NASDAQ would not issue warning letters to the company, and exempted many companies for several quarters.) Another way of stating these requirements is that the investment bank would not engage a company unless it believed that the engaged corporate client can meet the NASDAQ/NYSE minimum standards.
Contrast the NASDAQ trading policies with “penny stock” markets, the public stock profiled in the “Wolf of Wall Street” movie. Those stocks are even traded at less than a penny, for example, I know of one Irvine, California, company’s stock trading at $0.0029 per share. Institutional investors shy away from such stock as the stock lack liquidity and they trade with considerable volatility. Every ISO program will not get the maximum share value if the company follows this route. And I have not witnessed penny stock companies migrating upscale to NASDAQ.
So the long term strategy for an IPO is to pursue investment banks willing to engage the company so that it can be traded within NASDAQ or the NYSE. And that will only happen unless the company meets the NASDAQ/NYSE standards. That is how a company can reach the IPO Holy Grail.