Here is a dose of reality. As an entrepreneur you must have a firm grasp of where your company is now in the scheme of things. How strong is your management team? What are your total assets? Total Liabilities? Net Equity? Cash available and cash budget for the next year? Total Sales? Total Income (pre-tax and after tax over the current year, and previous two)? Total equity shares outstanding? Number of shareholders? You have to make progress within the framework of how much cash your business has, and how to raise working capital as you go along. You need to have a plan of where you want to be in two, five, seven years, and then plan backwards to get there. I was working on a private placement with a law firm in Los Angeles that was taking forever, and one day I asked the lawyer I was working with, how is it I read a rumor about a tender offer in the Wall Street Journal on a Monday; the next day the tender offer is announced; and by Friday there is a tombstone ad in the Wall Street Journal? His response was memorable; he said, if you bring in a $50,000 cashier’s check, and said you wanted this private placement done in a week, it would be done!
Another time, I was then the CEO of a publicly traded oil and gas production company, and my accounting firm, which was a small regional firm, was billing me $15,000 for my 10-K’s; and about $5,000 per quarterly report (10-Qs). Occasionally, I would have the firm do some special project that would cost extra, and we would have 8-K’s that would require reviewing. Thinking I was paying a lot of money for their services, and the (lack of) “name quality” of the firm, I went to a major accounting firm, with a check in hand, and told them I would like to hire them. After a review of my company, they said they would not take on my account because my publicly traded company was too small and would not generate enough revenue to justify the efforts and risk of the account. Wow! I thought all I needed was cash to hire anyone I wanted! Not so!! It is not easy to hire the best accounting firm, and if you could, it would be very expensive. It is the same with a legal firm. I was having breakfast one day with T. Boone Pickens, and he told me a story I have never forgotten . . . about legal fees. Boone Pickens was trying to figure out how to structure a proposed takeover of an oil and gas company. He had gotten to the point where he had run out of ideas and was stuck. He telephoned Joseph H. Flom, with the law firm of Skadden, Arps, Slate, Meagher & Flom LLP, in New York City. Boone Pickens laid out exactly what he wanted to do, where he was, and asked for Joseph H. Flom’s opinion as to how to resolve the problem. Joseph H. Flom immediately told Boone Pickens how to do exactly what he wanted. He then sent Mesa Petroleum, Boone Picken’s company, a bill for $1,000,000. I asked Boone Pickens if he paid the bill. He said, “Absolutely! You never know when I might have needed the same expertise again.” I think I have made the points here that you cannot always hire the named firms you would like, and if you could, they are very expensive.
Why go public?
While it is difficult to attract equity capital as a public company, it is almost impossible as a private company. A public company has more alternatives for raising capital both initially, and as follow-up capital raises. Here are some advantages of going public:
- Liquidity. Investors have an exit path for their investment. When an investor is considering making an investment, he/she is asking, 1) how much can I possibly make on this investment?, and 2) how do I get my money back? As your company develops as a public company, it will be easier to trade the equity, which will give the investment more liquidity.
- Ongoing financing. Positive results of management allows the company to raise additional capital via shareholder rights offerings, warrants, secondary offerings, institutional private placements, conversions of debt to equity, and other types of combinations of stock and debt offerings.
- Higher company value. A public company’s equity will sell for more than a private company’s equity. Investors in the private company discount the value of its equity by reason of their “illiquidity,” that is, the inability to sell their interest for cash.
- Personal wealth. It is a lot easier to value your net worth in publicly traded securities than the underlying asset. Bill Gates may not know how much his personal home can be sold for in the next week, but he does know what a share of Microsoft Corporation is worth in the securities markets. Stories abound of the many multimillionaires and billionaires who are created through public offerings.
- Increase competitive position in your market. Greater resources makes your business more competitive, gives you operating capital to penetrate your market, and gives you marketing opportunities only available to well capitalized companies.
- Prestige. You, and your co-founders gain an enormous amount of prestige from being associated with a company that goes public. Going public, or being public is a sign in the community that your business is doing well, and is going places.
- Attract key personnel. Being public gives you one more tool to hire top people. Being able to offer stock options to potential executives gives you the ability to hire people who may never talk to a private company.
- Ability to grow through acquisitions. It is possible to use your equity securities of your company as currency in an asset purchase. A private company cannot do this because the private company has nothing to offer that is liquid, and can be sold in the marketplace.
There are also disadvantages about going from a private company to a public company. Not everyone gauges success the same way. When you have one outside shareholder the way you look at your business and control the finances is different. Your fiduciary duties change and your concept of risk changes. You are now accountable to other people. Instead of making a decision by the seat-of-the-pants, you will run a spread sheet on the question and ask a series of “what if” questions. As a businessman growing your business, and employing many new people in your community, you will be derided by politicians as among the greedy rich. (In private they will tell you what a great job you are doing while asking you for a donation to their next re-election campaign). Your first round of financing will probably be founders, family, and personal friends. They start looking at you, not as their old buddy who was a near scratch golfer, but now as when do we get a stock dividend? No one ever thought of you running your business, but now you are under a microscope. You will be under a lot of pressure to succeed, grow the business, and make money by your shareholders and the investment community. If your company does well, it will be in a position to do another round of financing, grow and prosper. If your company does not meet expectations, the walls will start moving in. It is very important – no, it is critical – to be a good steward of the cash equity investors entrust with you, and make as much progress as humanly possible. Keep in mind using wisely the last round of financing sets up the next round of financing. As the leader of the business you need to show your investors, customers, and employees that you are in the business to win and to succeed. That is both a short-term and long-term commitment. In making a successful enterprise your business needs a good business plan, a marketable product, an experienced management team, and adequate capital. The faster your company grows, the more good people you will need and the more capital your enterprise needs for operating capital. As a public company you can offer stock options and share some of the equity. This will attract good people. Raising equity capital is also expensive. Your accounting costs and demands will drive you crazy. As your company grows, it will have to comply with more regulations and laws. Your financial statements will have another layer of scrutiny.
Is your company ready for an Initial Public Offering (IPO)?
What does it really take to go public with a major underwriter on a major exchange in the United States? Investors are looking for outstanding management. Investors invest in experienced and talented management. This management also has to have vision and integrity. The Company needs a superior technology, product or service in a large growing market. Substantial revenues are expected by underwriters and investors – at least $50 million to $75 million annually. Underwriters and investors are looking for revenue growth of 25% or more per annum. The IPO should be profitable. The market capitalization of the IPO candidate should be at least in the $200 million to $250 million range. IPO candidates need to be ready for public ownership in a number of ways, including accounting preparation, corporate governance, financial disclosure controls and procedures, and a variety of other corporate housekeeping tasks.
When the government talks about helping “small business” in the United States, they are not talking about any small business that I know about. I have been in business all of my adult life and I have never controlled a ‘nanocap’ business doing $50 million per year in revenue. To me, that is not a “small” business.
The large “wire house” underwriters, such as Credit Suisse First Boston; Goldman, Sachs; Morgan Stanley, Dean Witter; BancBoston Robertson Stevens; Donaldson, Lufkin, & Jenrette; Deutsche Banc Alex Brown; and, Merrill Lynch all say, with their large overheads, that it is not profitable to do an underwriting for less than $50 million. They have a limit on their cash fees of ten (10%) per cent of the offering amount, plus three (3%) per cent non-accountable expense allowance. Additionally, they can receive “soft compensation” of overallotment options, securities underlying warrants, options, and convertible securities. It is not unusual for an IPO to cost up to eight (8%) per cent in offering expenses, including, but not limited to legal, accounting, transfer agent fees, financial printing, and road show expenses.
If your company is already a publicly traded company, registered on any exchange, your options are different than the company that is exploring the alternatives of how to raise equity capital, and eventually become a public company. Your company has a history (maybe “baggage”) from all the time that it has been in business. It is time for reassessing and determining where your company is, what has worked and what has not, where your company fits in its industry, and so forth. For this company, it is a time for reassessment, repair, restructuring, housekeeping, and putting together a new plan for a new approach. This process could take two to five years, depending upon the situation and the quality of your financials, and where you want to take your company.
