Taking a Company Public: Which Companies Should Consider an IPO
Not every company can -- or should -- go public.
There is an array of factors to consider before summoning the bankers. These factors include meeting certain financial qualifications set by the various exchanges, the appropriateness of an IPO strategy for your business and business goals, and the market receptivity to IPOs generally and within your particular sector.
Exchange Qualifications
Before you can even consider taking your company public, you must meet certain basic financial requirements, which are set by the exchange where you expect to list.
For instance, if you want to list your company's stock on the New York Stock Exchange (NYSE), you will generally need a total of $10 million in pre-tax earnings over the last three years, and a minimum of at least $2 million in each of the two most recent years.
The NASDAQ Global Select Market requires pre-tax earnings of more than $11 million in the aggregate in the prior three fiscal years and more than $2.2 million in each of the two most recent fiscal years.
Fortunately, both exchanges have alternative markets that have less rigorous financial requirements for listing companies. The NASDAQ Global Market requires companies have income from continuing operations before income taxes in the latest fiscal year or in two of the last three fiscal years of $1 million or more. The NASDAQ Capital Market has a lower barrier to entry, requiring net income from continuing operations in the latest fiscal year or in two of the last three fiscal years of at least $750,000. Meanwhile, the NYSE's American Stock Exchange (AMEX) requires pre-tax income of $750,000 in the latest fiscal year or in two of the three most recent fiscal years.
The exchanges also offer alternative listing standards based on cash flow, market cap, and revenue for larger companies not meeting the pre-tax earnings' tests.
Under SEC rules, a company must also have three years of audited financial statements before it can register to go public. If a company lacks three years of audits, it can often create them 'after the fact,' Rowe says, assuming it has the records and systems in place to allow an auditor 'look-back.' Since that can be a costly and time-consuming undertaking, pre-planning is essential.
Dig Deeper: Stock Exchanges and Securities Laws
Taking a Company Public: Picking the Right IPO Strategy
Even if a company meets the minimum requirements for listing on one of the exchanges, it may not be in the company's best interest to go public.
"I think businesses should go public that have achieved a size that would allow them to have a predictable revenue and earnings stream," Evans says. "Smaller businesses tend to be more volatile and there is a premium paid for predictability in the public markets."
Another factor to consider is whether your business will have a market capitalization large enough to support enough trading in your stock that buyers consider that stock to be "liquid," Evans added. "To go public with too small a market cap means that buyers don't get a really liquid public security. The reality is that unless you have enough of a market cap, I think public offerings are probably best for growth companies."
Market Considerations
Another factor that is increasingly determining whether companies go public is the economy and, in particular, the public's appetite for IPOs.
The IPO market hit a 30-year low in 2008, when only 31 companies went public on the major U.S. exchanges, according to Hoovers. Nine years earlier, in 1999, there were 477 IPOs, more than half of which were venture-backed, according to the National Venture Capital Association (NVCA). Market interest in IPOs definitely waxes and wanes – especially recently. The good news is that the IPO market picked up slightly in 2009, when 63 companies went public on the major U.S. exchanges, with virtually all of that activity occurring in the second half of the year.
"There is a pipeline, things are turning around," says Evans. But he says the market for IPOs would get better if some of the regulations in the Sarbanes-Oxley Act were pared back. The law, which sought to provide the public with more corporate accountability, requires compliance with so many costly rules that the overhead associated with compliance "adds millions to a company's operating expenses," Evans says. "Companies tend to have to wait longer now to overcome that expense before they can go public. It's a direct impediment to their ability to go public."
Another component of the law requires CEOs and CFOs to personally certify financial and other information in their securities filings. "Quite frankly, it makes it less attractive in some instances to want to take that on," Evans says.
Dig Deeper: The Declining IPO Market During a Recession
Taking a Company Public: The Steps You'll Need to Take
If your company meets these financial requirements, you determine an IPO will help you meet business goals, and the market conditions appear right, then it's time to begin the IPO process. Typically, it takes four to eight months to complete this process, from the time you actively engage underwriters to the time you close the offering. Here are the key steps in the IPO process:
Put the right management team in place.
Fast growing companies generally have strong management teams already in place, but the demands of becoming a public company often require additional strengths and capabilities. The senior management team must have considerable financial and accounting experience in complying with increasingly complex financial and accounting requirements. In light of this, many pre-IPO companies seek to recruit CFOs or other executives from outside who have had experience going public with other companies. "I don't agree with that at all," Evans says. "An experienced CFO that knows his or her business well, and who has been successful in that role, doesn't need to have gone through a public offering before." But it is important that key managers possess strong communication skills to present the company's vision and its performance to the market, and to meet the often-intensive informational demands of research analysts and investors.
The composition of your board of directors may also need adjustment. The exchanges require that a majority of the company's board of directors be 'independent,' and that the audit, compensation, and nominating corporate governance committees -- to the extent they exist -- be composed of independent directors. In addition to creating even more stringent independence requirements for audit committee members, Sarbanes-Oxley requires an issuer to disclose whether it has an 'audit committee financial expert.' To meet these requirements, independent board members (who are not insiders or affiliates) may need to be recruited, particularly for the audit committee, Evans says.
