One of the biggest decisions a growing company will face is whether to go public. To some company founders, selling shares is akin to reaching the brass ring -- the ultimate business dream. Why? Because although the road to a successful IPO is dotted with regulatory hassles and higher expenses, the reward is investment capital -- money that can be used to build the business. Several 2008 Inc. 500|5000 companies have braved this road with their sites set on the prize, and they shared with Inc.com the highs and lows of the process.
The first, and arguably most important, consideration a company must make when deciding to go public has to do with capital. Selling shares to investors can produce a quick influx of capital to companies. This capital can be useful for companies in need of liquidity and can provide a reward to early investors seeking a ROI, explains Rick Stover, Chief Technology Officer of Energy Recovery, No. 396 on the Inc. 500 list this year. "We had long-term investors that had money in the company for up to 20 years and who wanted some liquidity."
Going public can be helpful because it introduces a company and its products to a much wider audience. Energy Recovery, which went public in July, manufactures an energy recovery device that derives energy from desalination seawater plants. Increased visibility on the American stock exchange spurs stock activity and in turn has created new interest in its technology, "inquiries that we would not have had we not gone public," says Stover.
Presenting itself as a public company has beneficial repercussions for the general public, as well as investors. The media is tuned into what goes on with the stock market and keeps the public informed about public companies. Also, investors are more likely to invest if they are confident the company is complying with Sarbanes-Oxley and is reporting earnings regularly.
However, filing an IPO cannot just be looked at as a way to make easy cash. The costs and headaches associated with the process can be too much for many private companies to handle. The process of going public can take anywhere from six months to a year. A company must develop its story to sell to underwriters in the road-show process in which the company repeatedly presents itself to investment banks. "It's surprising how grueling it is to tell your story over and over again," says Adam Singer, CEO of IPC The Hospitalist Company--No. 3,198 on the 2008 Inc. 5000 list. For Stover, it was the scrutiny by lawyers and accountants that was most difficult to deal with.
Companies may have to make internal changes to comply with SEC regulations. Energy Recovery brought on a new CFO and controller to improve financial discipline and control and regularize financial reporting. Intrepid Potash, No. 3,122 on the Inc. 5000, also added a CFO. Ranked at No. 1,611 on this year's Inc. 5000 list, Heritage-Crystal Clean, No. 3,682 on the Inc. 5000, an environmental services firm, already had "established independent relationships for our banking, audit and accounting, and information technology," says CFO Greg Ray. Singer has a positive attitude about what can be a draining process: "Try and embrace whatever the new rules are," he says, "you can fight these rules, or you can be a better company by complying."
Red Tape and other Barriers
Making all of these changes costs money. Compliance with SEC regulations and procedures "can be a real strain for smaller companies," drawing away from their bottom lines, says Paul Bard, Vice President of Renaissance Capital, an IPO research firm. It is generally considered optimal that a company have a minimum of $100 million in revenue before considering going public. Smaller companies are viewed as riskier by investors. This concern is echoed by Ray of Heritage-Crystal Clean. "For our company, the key consideration was whether we had reached adequate size for a successful IPO. We knew that we wanted to go public at some time; the main question was when. If investors had considered us too small, then we would have deferred our IPO." For RiskMetrics, going public was made easier by the acquisition of two companies, which doubled the firm's size.
The costs don't ebb once a company makes it to the stock exchange. Operating as a public company invites a host of expenses involved with financial reporting. Costs can stem from the need to keep shareholders informed about your company's operations and finances. Shareholder approval is often needed before executives can take action, a mode of operation that can take some getting used to for most entrepreneurs.
Last year, we listed the Top 100 Inc. 5000 Companies Intending to Go Public. Of those 100, just 10 actually completed and are currently trading shares. This reflects a general trend in the equities market; there is always a discrepancy between those companies that file IPOs and those that make it to the pricing stage. According to Renaissance Capital's IPOhome.com, in 2007, a total of 374 companies filed; 273 priced. As of this writing, 133 companies have filed IPOs thus far in 2008, and 42 have priced.
What happens in between filing and pricing? Three things, says Bard: companies go public, withdraw their IPOs, or are acquired. Withdrawals can happen for several reasons. For Convio, which filed an IPO in August 2007, going public started to make less financial sense because the company was already doing so well. The company is ranked No. 965 on the 2008 Inc. 5000. There is "no reason to accept a valuation below what we're worth," said Tad Druart, the company's director of corporate communications. Some companies may want to go public in the long-term but withdraw their IPOs because of the current equities market. This was true for Varolii, which pulled its offering off the table in June, but may file next year if market conditions improve. Bard says that this year the "pipeline" of companies waiting for better conditions, "has been increasing."
Bard reports that when IPOs are performing well and shares are trading up, there is a beneficial effect on the overall equities market and the economy in general. It shows that investors are willing to fund new ideas and previously unheard of businesses. The problem now is that demand for the new is low. Investors are being much more cautious. Improvement of current conditions, Bard says, is reliant on several factors: stabilization in the wider economy and the introduction of some well-performing IPOs. Because "the IPO market is very momentum driven," a few winners could turn the whole thing around and increase demand. The market isn't bad for all companies. As the largest producer of potassium chloride in the United States, Intrepid Potash made the decision to go public based on the booming commodities market.
Bard says the probability of a successful IPO can be improved if a company exhibits three features: annual revenue of at least $100 million, profitability before the IPO filing, and strong profitability margins. "Make your business as strong as possible going into the public offering," says Stover. Still, there are no guarantees. When No. 1,186 on the Inc. 5000 list,Rackspace Managed Hosting, an IT Services firm that provides managed hosting services for businesses, went public in August, expectations were high. However, as John E. Fitzgibbon, Jr. reported on IPO Scoop.com, "it was the worst opening-day performance by an IPO since…Nov. 6, 2007." The value of Rackspace's shares dropped by 20 percent in one day.
Does industry matter? If we look at our 2007 companies that completed their filings, we would say no. All of the 10 companies that completed their IPOs were in different industries.
|Duff & Phelps||Financial|
|SoundBite Communications||Business Services|
|Constant Contact||Advertising and Marketing|
|Intellon||Computers and Electronics|
For 2008, we see some evidence of trends, with two environmental services firms, two health firms, and two financial services companies going public. If we include the companies that have filed IPOs, but have yet to complete their offerings, the health trend strengthens, with an additional five firms that have filed. Other popular industries are IT services, with four filings, and Software, with three.
So, how does it look for this year's Inc. 500|5000 companies that have gone public? By examining the data from Energy Recovery, RiskMetrics Group, CardioNet, Intrepid Potash, IPC The Hospitalist Company, Heritage-Crystal Clean, Colfax, and Visa, Bard was able to determine that the average performance for these companies was 43 percent year-to-date. As a comparison, the entire IPO market has a rate of return of 3 percent. And the data isn't skewed by Visa's big IPO as much as you might expect. Even without Visa, the average return is 40 percent. Why? "These are close to hitting the $100 million revenue mark or above, an important threshold. Every one was profitable at time of going public, and each has profitability margins stronger than the average S&P 500 company."