In the last two issues, we outlined why some private entrepreneurial businesses go public — and why many do not. If you have worked through the pros and cons of becoming a public company, and you do want to sell shares in the public market, we now turn to the process of the initial public offering (or IPO, as it is colloquially known).
The Internal IPO Team
The first process step is to organize the team that will stickhandle the complicated legal, regulatory and financial exercise that is an IPO. Internally, your CFO and CMO (Chief Marketing Officer, often a VP Marketing) will be two key people, usually with important input from the CEO and various other senior officers of the company.
One challenge you have is that the IPO process will suck up a large amount of the CFO’s and CMO’s time (up to six to nine months, the typical length of an IPO process). It will mean that these two important people will have much less time for their "daily jobs." So, ideally your company has planned for this and is able to shift some of their usual duties to others.
However, it is not uncommon, particularly with smaller, growing, entrepreneurial companies that go public, that several others from the senior management team (in particular, the VP Sales) get too involved in the IPO process, such that the company takes its eye off the ball for a couple of quarters (especially in terms of pursuing and closing sales). The result can be, for example, that sales suffer in the quarter or two following the IPO. This can then lead to a drop in the (now publicly traded) share price of the company to below the IPO issue price, a situation that can be discouraging to investors and employees alike (employees because they typically have options to buy shares of the company).
Therefore, it is critical that you have all senior management exercise discipline in terms of the amount of time devoted to the IPO process. The team cannot lose sight of the fact that as exciting — and challenging and important — as the IPO process is, there is still a business to run (if not more so, now that you will soon be a public company, and everyone will see your next quarterly financial results). Through diligent planning and execution, the more successful IPOs will use the process as a springboard to more growth and opportunity.
In addition to your internal team, the IPO process will require you to harness the talents and efforts of at least three different external advisors. First, you will need an investment banker (and their investment bank) to be your underwriter for the going public exercise. The banker will tell you whether the financial markets will want to buy shares of your company, and at what price. They will conduct due diligence (they will have a law firm and other advisors assist them with this process) on your company (more on diligence in next issue), and will help craft the all-important prospectus document (more on this key document below and in the next issue).
Most importantly, the banker will help sell your shares. They will determine with you what mix of retail and institutional public shareholders makes the most sense for your company. Then they will reach out through their distribution channels to build an order book for your shares towards the tail end of the IPO process. Particularly if you are a younger entrepreneurial company without a significant track record, the credibility and reputation of your banker will be important.
The IPO process is an extremely intensive legal exercise. In order to protect the investing public, and generally the integrity of the public stock markets, a host of legal rules and regimes surrounds the prospectus and other aspects of the IPO process. You will need a law firm with two strengths to assist you through the going-public exercise. Of course the law firm must have solid expertise in securities law, and specifically with IPOs. But it should have deep experience in your industry sector as well, so that it fully understands your unique business model. This knowledge will be invaluable in crafting the prospectus and conducting due diligence.
Finally, you will need an accounting firm to help you work through the numerous regulatory requirements surrounding your financial statements, internal controls and other accounting-related requirements. As a threshold matter, your prospectus will have to include audited financial statements for the last three fiscal years as well as unaudited quarterly statements for the current fiscal year. But the accountant will help in other ways as well, including assisting with financially oriented portions of the prospectus, such as the MD&A section (Management Discussion and Analysis), where you have to give a meaningful explanation of your financial results in narrative terms.
Yes, all this hired help is going to be expensive. The banker will typically charge a fee equal to six to eight per cent of the amount of money raised from the new public shareholders through the IPO process plus certain expenses they incur on your behalf as part of the process. The lawyers and accountants typically charge on an hourly-rate basis. Then there are printing costs for the prospectus, as well as French translation costs for the prospectus if you want to see your shares sold in Québec. And if you want to sell some of your shares in the US, there will be additional costs for US legal assistance.
When you are working up the budget for your professional advisors, however, we would suggest you look beyond the raw dollar amount of the fees, and instead consider these costs relative to the total funds raised in the IPO process. Moreover, saving professional fees by cutting corners on items like due diligence is not a good idea, given that significant personal and corporate liability can attach to a faulty prospectus. So, as with all premium legal, accounting and other professional services, the real touchstone ought not to be cost but value.
The All-Important Prospectus
Once you’ve assembled your working group (of internal company people and your external advisors), the focus of the IPO process turns to the crafting of the all-important prospectus. This is the document that the law says you must give to prospective investors in your soon-to-be-public company. The prospectus is a critically important document.
To understand the pivotal role of the prospectus, consider the difference between selling shares of your company to hundreds of retail (i.e., individuals) and perhaps tens of institutional (i.e., mutual funds) investors (which is essentially what the IPO process is about) to selling shares to a venture capital investor (VC), which you likely did a few years ago when you were at an earlier stage of development as an entrepreneurial company.
The VC was a seasoned investor in entrepreneurial companies, and in particular in your industry space. So the VC thoroughly understood your market, business and your challenges, and then personally conducted due diligence on your management team, your technology and your financials. In short, the VC got to know you really well, and by sitting with you in numerous meetings, the VC had all of its specific questions answered. Then the VC’s lawyer prepared a share-purchase document in which you gave a long list of representations and warranties about your business. Only after all of this information exchange did the VC invest several millions of dollars to purchase your shares.
For practical purposes it is, of course, impossible to repeat this detailed, personalized information exchange process when selling shares to hundreds of public investors. The alternative is the prospectus. This document must give "full, true and plain" disclosure of all material facts relating to your company and its business and the securities to be sold, so that prospective investors can come to understand your circumstances before they decide to buy your shares. This is the core public policy "deal" reflected in the securities legal regulatory system — namely, you can sell your shares to people you have never met before, provided you deliver to them a meaningful prospectus document so that they can make an informed decision.
In the next issue, we look at the various particular requirements of the prospectus, and the due diligence process that needs to underpin the document.