Serena Software Inc., in Burlingame, Calif., which manufactures enterprise software for large corporations, learned that the hard way. Serena was founded in 1980 and has enjoyed debt-free status and uninterrupted profitability since its first year of operation. "During the late '90s, we knew we wanted to go public," says Mark Woodward, the company's CEO, "because we wanted to be able to incentivize our employees and raise cash and have the stock currency for future growth-oriented activities. But it was completely impossible to get any of the top firms to pay attention to us, because we weren't a super-fast-growth company and we didn't have any venture capitalists involved."
ROAD WARRIOR: "I've had to work very hard to expand our analyst coverage in the stock market," says Serena Software CEO Mark Woodward.
Serena managed to go public in February 1999, but the company needed to rely on an underwriting team that consisted of three small second-tier firms. "We raised $60 million, which was great. Our market capitalization got as high as $2 billion, and even now it's still around $1 billion," notes Woodward, whose company's revenues are now just under $100 million. "But the truth is, I've had to work very hard to expand our analyst coverage in the stock market. When you go public with a second-tier firm, it's difficult to attract coverage by the big research analysts, and it's hard to win the Fidelitys of the world as your long-term investors, which is what you want because those are the kind of investors who will give stability to your stock."
The best underwriters have very strong ties to the institutional market -- mutual-fund investors, insurance companies, and other institutional investors. "These firms look consistently to place around 80% of their IPO offerings with the best of those investors, meaning those buyers who have a history of making long-term bets on companies," notes Jeremy Dickens, a partner and cohead of the capital-markets group at Weil, Gotshal & Manges, a New York City-based law firm. Less-desirable underwriters tend to rely on teams of brokers to place the bulk of their IPO offerings with retail customers (meaning, individual investors) or hedge funds -- funds that tend to aggressively turn over their holdings.
During the past few tumultuous years, all kinds of investment banks -- big and small -- were overly optimistic about their ability to bring IPOs to market. For instance, in 2000 there were a whopping 318 withdrawals of IPO registrations. But as the public-offering market gradually recovers, the most successful underwriters undoubtedly will be those that combine selectivity and high standards with a keen understanding of what their institutional clients will and won't buy.
"It's better to have a good firm advise you to wait than to try an IPO with a less reliable firm and fail," says John Egan, cohead of the private-equity group at the Boston office of law firm McDermott, Will & Emery. "If your employees, investors, and customers start to expect an event that doesn't happen -- even through no fault of your company's -- you can start looking a little shopworn. People get demoralized or distrustful."
Mediocre underwriting firms can harm their clients with more than bad advice. "Entrepreneurs may tell themselves that the worst that could happen to them is a failed IPO, but that's just not the case," emphasizes Glenn Kaufman, a managing director at American Securities Capital Partners, a private-equity firm based in New York City. "The worst is, your company succeeds at going public, but it never finds a home with investors, it never gets any analyst coverage or attention, and it's got an underwriter who cannot or does not support its performance in the aftermarket. So you've got none of the advantages of being public but all of the costs, obligations, and challenges of public reporting."
The best measure of an underwriting firm's strengths (or lack thereof) lies in the services it performs after a stock goes public. "When we're thinking about taking one of our portfolio companies public, the first thing we look at is the research capabilities of the underwriting firm. We'll look for an investment bank that's got the best research analyst in our industry," says John Castle, chairman and CEO of Castle Harlan Inc., a New York City-based private-merchant bank, which manages more than $27 billion in assets. "That person will be best able to understand what's going on in our company. And he or she will have the credibility within the investment community to present us and our prospects in the most effective light."
A top-quality underwriter can help a company's stock, whereas a subpar firm can damage it, through support (or lack of support) for that stock in the IPO aftermarket. No illicit activities or covert stock manipulations are involved. It's as simple as this: If an investment bank believes in a stock that it has underwritten, and if the bank is sufficiently capitalized to back up that belief with its actions, then it will buy the stock aggressively when others are selling. It will then either hold the stock as an investment or gradually sell it to institutional investors, helping to stabilize the price either way.
