Foundations of New Venture Finance 269IPO: Not an Automatic Yes
Entrepreneur Yuchan Lee says the decision
to take his company public involved both logi-
cal “left brain” and intuitive “right brain” judg-
ment. Lee’s Unica (www.unica.com) market-
ing management software company had
already raised $11.2 million in private equity
and been named one of Inc.magazine’s
fastest-growing companies for four years in a
row before its IPO in August 2005. Still, Lee
weighed a number of factors before taking
the big step.
“The left brain portion is straightforward,”
Lee explains. “The financial market has a fair-
ly clear set of parameters around which com-
panies are qualified to go public from a met-
rics standpoint: revenue level, revenue
growth rate, operating income, EPS, market
potential, market position, management team
completeness, and so on.
“The more subtle part of this decision is
the right brain portion,” Lee suggests. “That is
a judgment about a level of confidence, from
international operation readiness to market
momentum.”
There are distinct advantages and disad-
vantages to taking a company public through
an IPO, all noted in Street Story 7.2. For the
business itself the advantages include cash
for the company to expand, cash the compa-
ny can use for acquisitions or mergers,
greater accessibility to long-term debt for the
company, increased employee benefits plans
and incentives with stock, and increased pub-
lic awareness of the company. For the com-
pany’s early investors, including the founding
entrepreneurs and top managers, the benefits
can include cash when their equity is
exchanged for publicly-traded stock, the
establishment of an ascertainable value of
the company, equity made available for exec-
utive incentives and compensation, liquidity
for entrepreneurs, financial control of the
company, and personal satisfaction.
VentureOne, a research firm owned by
Dow Jones & Co., reports that IPOs of U.S.
companies dropped 9 percent, from 237 in
2004 to 215 in 2005. The decline in the sub-
set of IPOs backed by venture capitalists was
more dramatic: a drop of 39 percent from 67
in 2004 to just 41 in 2005. Venture-backed
IPOs also raised 45 percent less in the third
quarter of 2005 than during the same period
the previous year.
One reason for the downward trend may
be new auditing and fiscal reporting require-
ments, including the 2002 Sarbanes-Oxley
law. This legislation requires top managers to
certify the accuracy of the company’s
accounting, information technology, and con-
trol systems, and imposes stiff penalties for
any violations.
Questions an entrepreneur should ask
when considering taking his or her company
public through an initial public offering
include:- Is your company big enough? IPOs today
should be able to generate at least $75 to
$100 million through stock sales and
shareholder selling. - Is your company growing fast? Institutional
investors are generally looking for strong
growth prospects. - Do you have an experienced CEO and
CFO? Do you have other pieces of sound
corporate infrastructure in place? - Can your company accurately forecast
revenue and earnings? Shareholders who
think they’ve been mislead may initiate
lawsuits. - Is the market environment right? Are com-
panies similar to yours getting the financ-
ing they want? - Is your company ready? An IPO generally
takes a year from the first organizational
meeting, and top management will still
STREET STORY 7.3