A guide to the uncharted territory of small-company public offerings

Whatever 1997 has in store for small-company initial public offerings, it's not likely to match the singular accomplishment of small enterprise--in many cases, really small enterprise--in 1996. In the best year ever for IPOs, exactly 200 operating companies (by Inc.'s measure) with revenues of $10 million or less went public, and of them, exactly 41 had revenues of $100,000 or less. You wouldn't know it by the celebrity lavished on Lucent, Revlon, and the big-deal end of the market, but those little companies represented more than one-third of the Year of the IPO. Unfortunately, despite the pink-cheeked promise of those companies, their shares didn't all go up. Still, the year featured several other types of small-company "ups." One was the rollup, an instant-revenue strategy in which an entrepreneur acquires a series of little independent businesses in the same unconsolidated industry, packages them under one corporate umbrella, and takes the whole lot of them public at once. Then the corporation applies the value of its new public stock to acquiring yet more little businesses in what, conceptually at least, promises to be a never-ending expansion.

Not uncoincidentally, another characteristic of '96 was the blowup. A blowup is a nasty surprise sprung on sanguine investors, in which a newly public company announces a horrible earnings quarter, thereby tanking its stock. And tied in with both of the foregoing is the lockup, the underwriter-mandated period of six months or more after an IPO, during which earlier investors (as opposed to current IPO investors, who widely indulge in "flipping" for immediate profit) are restrained from dumping their suddenly enhanced holdings into a fragile aftermarket. That interval of prohibition has hardly been noticed in the feeding frenzy of recent "up" markets, however, and it has gradually gotten shorter.

Then there are the traditional roundups, chronically inaccurate year-end evaluations of the market in Barron's and other representatives of the financial press. This year's roundups gave various tallies of the number of deals in '96, from fewer than 500 to as many as 850. The discrepancy is to some degree attributable to a custom dating back to the boiler-room days of the early 1980s, when financial commentators felt obliged to ignore offerings deemed unsuitable for laypeople's attention (with good reason, considering that some underwriters actually served time). And commentators remain judgmental to this day: for example, almost all the '96 roundups skipped offerings that came to market without the backing of investment bankers, although at least one issue managed by a company CEO thrashed the underwritten crowd. (See " You Don't Know Me....") And when the IPO aftermarket started to crumble at midyear, many blamed the malaise on a host of still-green companies that had been rushed to the market at any price to take advantage of its insatiable appetite for equities. "In many instances, the investors involved at the venture level and, of course, the people running the business think they actually have a good company," notes Tom Stephens, director of Institutional Equity Sales at Tucker Anthony Inc.'s office in Washington, D.C. "But the truth is, in bull markets people believe in bullshit."

Rightfully or not, many roundups, such as Renaissance Capital's otherwise thorough IPO Intelligence subscription letter, simply ignored issues that were priced at a putatively insubstantial $5 or less. That barrier left out 42 businesses, a dozen of which proved strong enough to trounce the year's 12%-or-so average gain of all IPOs, big and little. (See below.)

In this special section, Inc. reviews the '96 market from half a year's distance, with an eye toward those and other emerging-into-public companies that commentators tended to slight. Not to say that Inc.'s criteria weren't themselves exclusionary. We ignored spinoffs such as Lucent, since we don't consider them to be truly emerging. Issues that came to market with sweeteners attached, such as warrants or convertibles, we also dismissed, together with nonlisted stocks. And we omitted real-estate-investment trusts, oil-and-gas explorers, holding companies, financial institutions, closed-end funds, and foreign entities, on the grounds that including such anomalous structures scrambles data into an apples-and-oranges mÉlange.

To examine the small-business end of the market, we included only companies that reported annual revenues of $10 million or less at the time of their filing. The 200 companies thus defined as small businesses effected a collective market capitalization of $19.3 billion and put a solid $4.8 billion in public dollars into play. Not too shabby. But while a couple hundred mostly early-stage businesses, ranging from cigar rollers (see " Light Up. Go Public. Quit Your Day Job") to biotech labs, can't be expected to form a uniform picture, they do illustrate some interesting trends.

One explanation for critics' bewilderment when it comes to small businesses like these is some companies' ability to pull off their IPOs despite a total lack of earnings. Although Netscape Communications showed the way in 1995, the confusion remains understandable. Among the entire group on Inc.'s list of 200, 29 not only reported no earnings but had no revenues as well. Add to those businesses showing double naughts another 12 companies that had revenues of $100,000 or less. All told, those 41 companies constituted a full fifth of the lot. Which explains why the companies in this group were widely dissed as being of "poor quality." But in a notable display of counterintuition even for Wall Street, they fared surprisingly well in the aftermarket--a remarkable performance that suggests that when it comes to investing, a string of zeroes is a mark of character among really small companies. (See below.)

The 1996 market probably resembled that of 1983 more than it did the markets of 1995 or 1993. In those three years, statistical records also were set. But the rush to go public, so much in evidence in 1983, was a hallmark of the 1996 market, as was a major midyear correction in both years.

Because the market "is heading toward the end of an extraordinarily long IPO cycle," says Wall Street veteran Tom Stephens, who packaged public offerings in '83 for a small underwriter, "lots of companies were too early to be in the hands of the public. They really should have been late-stage venture or mezzanine deals." The parallel between '83 and '96 is "uncanny," Stephens notes. "Back in '83 shops like ours cranked out a lot of crap," he admits. "If you thought you had a shaky, overpriced deal, you got it public quickly so the venture guys could get rid of the thing. We brought out one company at 7 and a year later it was 11--Chapter 11."

Although one underwriter was investigated by the Federal Bureau of Investigation and the SEC last year, on the whole the bankers of our small-company group behaved better than that: as of the spring of 1997, not one of their issues had gone under. The issues did, however, manage to lose 1.4%, on average, from their IPO date to the end of the year.

So, did 1996's burst of immature companies going public signal the end of a speculative IPO market? On the contrary, attests John Hentrich, a partner at Baker & McKenzie, a prominent West Coast law firm, who specializes in handling public offerings. "In 1996 there was a significant increase in the ability of emerging growth companies, especially technology companies, to effect a public offering at an earlier stage than they used to," he says.

"To my mind, '96 was epochal," effuses Hentrich. "It was broader and more solid than '83. Whenever a market gets hot, there are bound to be frothy transactions that get carried along with the others. But there's another side: in the early '80s many of the companies that the overaggressive investment bankers took public failed, but a number of others actually became major industrial enterprises. Most of the funding I saw this year went to quality companies that, with that infusion of public money, will be able to offer products and services sooner than they otherwise could. It's a tremendous plus for the economy."

That may be. But is it possible that last year marked a juncture in which the economy ran out of quality private companies to fund--especially given that the market for initial public offerings, which posted caution flags in June of last year, has kept those flags flying into the first months of '97? Not to Hentrich's thinking. "Capital has been increasing at a tremendous pace," he acknowledges, "but there's also been an explosion in productive areas of investment. To my mind, '96 represented a culmination of the growing concentration of technological and entrepreneurial talent in the United States, combined with the availability of capital to continue to fund that talent. It came together in a way that I think is going to be regarded as special when we look back on it, and it's the IPO market that's driving all this energy."

How this unprecedented IPO boom will end is, of course, unclear. But one thing is certain: the market does purge excesses, as it did in '83. To be sure, the makeup of the market has changed since then, from being composed mostly of gullible individual investors to being about 75% made up of institutional trust departments, money managers, and mutual funds today. But, notes Tucker Anthony's Stephens, the pros are just as subject to euphoria and poor judgment. "Young bankers and managers caught up in the momentum of markets do things no gray-hair would think of doing. A lot of them buy weird stuff. They haven't experienced how bad it can get when it gets bad."

Wall Street's senior set has been warning about the possibility of an abrupt turnaround since the beginning of the bull cycle, in 1991. It has been wrong all these years, but starting in the latter half of '96 and continuing into '97, IPOs have been going off at the lower end of their target stock-price ranges and staying there awhile, rather than more than doubling the first day out, as, say $1.4-million Yahoo! did in '96.

"The window has closed to a certain degree," observes John Canepa, a partner in the high-tech practice of Arthur Andersen in Boston. "So far in '97, it's more like a screen." Oddly enough, companies with low to no revenues have continued to complete IPOs. That's no longer because of speculation fervor, Canepa holds, but because of a sound rationale: product-development cycles have shortened dramatically, and whereas only a few years ago companies took as many as five years to bring out a product, most now do it in two. As a result, emerging businesses legitimately seek public funding far sooner than they used to. "Because products become obsolete more quickly," he explains, "small businesses constantly need money so they can bring out that next generation."

Now that the market has cooled, there are plenty of companies that, failing to get sponsorship within their hoped-for price range, have withdrawn their offerings. But getting to that stage can be expensive, counsels Bruce Emmeluth, managing director of corporate finance at Van Kasper & Co., an investment banker in Los Angeles. Today a small company will do itself a big favor by rethinking its ambitions. "Underwriters get paid whether or not a deal is completed," he says. "So if you have a deal that aborts at the end, not only are you out your time, you're also out a lot of money." In short, if a deal isn't doable, don't force it. A CEO could end up relying on a mighty expensive red herring to raise private funds.

Sources for charts: Securities Data Co., Moody's Investors Service, and Inc.
*Companies with $10 million or less in revenues at time of 1996 IPO
1Before 3-for-1 split

Company Business description Symbol Revenues (in millions) Offer price per share Year- end price per share % increase
Paravant Computer Systems Mfrs. computers & interfaces PVAT $8.5 $5.00 $15.75 1 215.0%
InVision Technologies Mfrs. computer tomography systs. INVN 9.7 11.00 33.00 200.0
TriTeal Provides systs.-design svcs. TEAL 9.7 8.00 21.25 165.6
Triangle Pharmaceuticals Mfrs. pharmaceuticals VIRS 0.0 10.00 22.88 128.8
Neopharm Provides physical- research svcs. NEO 0.0 7.00 16.00 128.6
WebSecure Provides data-processing svcs. WEBS 0.1 8.00 18.00 125.0
American Wagering Owns & operates gambling machines BETM 9.3 6.00 12.75 112.5
Develops prepackaged software VSGN 7.6 7.50 15.25 103.3
Bristol Technology Systems Sells office equip. BTEC 7.2 6.00 11.63 93.8
Intensiva Healthcare Owns & operates HMOs IHCC 7.4 6.00 11.25 87.5
The Pros

The top-ranking firms that
helped companies with revenues
of $10 million or less go public in 1996

Top 5 Accountants
  1. Ernst & Young LLP
  2. Arthur Andersen LLP
  3. KPMG Peat Marwick LLP
  4. Coopers & Lybrand LLP
  5. Price Waterhouse

Top 5 Underwriters

  1. Robertson, Stevens & Co.
  2. Alex. Brown & Sons Inc.
  3. Hambrecht & Quist LLC
  4. Montgomery Securities
  5. Cowen & Co.

Top 5 Lawyers

  1. Wilson Sonsini Goodrich & Rosati
  2. Cooley Godward LLP
  3. Venture Law Group
  4. Brobeck, Phleger & Harrison LLP
  5. Hale and Dorr LLP

*Companies with $10 million or less in revenues at time of 1996 IPO
1Before 3-for-1 split

Top 5 Aftermarket Performers with $5 Offering Price*
Company Business description Symbol Revenues (in millions) Offer price per share Year- end price per share % increase
Paravant Computer Systems Mfrs. computers & interfaces PVAT $8.5 $5.00 1 $15.75 215.0%
Semiconductor Laser International Mfrs. semiconductors SLIC 0.0 5.00 7.50 50.0
Intellicell Sells wireless- communication prods. FONE 3.8 5.00 7.38 47.5
Hollywood Productions Provides theatrical motion pictures FILM 3.4 5.00 7.25 45.0
V-ONE Sells computers & software VONE 3.1 5.00 7.25 45.0
Top 10 Aftermarket Performers with $0 in Revenues at Time of IPO
Company Business description Symbol Offer price per share Year- end price per share % increase
Triangle Pharmaceuticals Mfrs. pharmaceuticals VIRS $10.00 $22.88 128.8%
Neopharm Provides physical- research svcs. NEO 7.00 16.00 128.6
Ultrafem Mfrs. women's health prods. UFEM 10.00 17.50 75.0
Semiconductor Laser Intl. Mfrs. semiconductors SLIC 5.00 7.50 50.0
Nuwave Technologies Mfrs. radio, TV, & broadcasting equip. WAVE 5.00 7.00 40.0
Biofield Provides medical-research svcs. BZET 11.00 15.38 39.8
Mfrs. lab
CALY 6.00 8.25 37.5
CyberCash Develops Internet software CYCH 17.00 23.00 35.3
NetLive Communications Provides computer integrated svcs. NETL 5.50 7.25 31.8
Heartport Develops systs. for surgery HPRT 21.00 22.88 8.9

Robert A. Mamis is a senior writer at Inc. The charts were prepared under the direction of editorial information manager Beth Gunn. Reporter Mike Hofman provided additional research assistance.


Considering that initial public offerings for companies involved with accessing the Internet have been particularly hot over the past couple of years, it's only fitting that the Internet should become a good source of information about IPOs.

Hoover's business resources proffer an illustrated, information-filled cybercourse on IPOs. It includes excerpts from business-school lectures and samples of documents involved in registrations.

Yahoo!, a 1996 IPO in action, features a finance page that offers " U.S. IPO News," which describes upcoming new public offerings and gathers Wall Street gossip.

For a basic explanation of how IPOs work--and good definitions of the lingo--see the March 1993 Worth article by Peter Lynch, " IPOs Explained."

Nasdaq's Web site provides news about every Nasdaq company, including current stock quotes, company news, historical graphs, and portfolio capabilities. The Web site of NASD Regulation, the regulatory arm of Nasdaq, describes broker/dealers, registered reps, and regulation of markets. You can also find information about arbitration and mediation there.

The Nasdaq Stock Market publishes Going Public, a 71-page book that details all the critical aspects of the IPO process. For a free copy, call 202-496-2600.

To read about one company's experience getting ready for its IPO, see " The 100-Day Makeover," by John Kerr, in Inc., May 1996.

BAKER & MCKENZIE, John Hentrich, 101 W. Broadway, San Diego, CA 92101; 619-236-1441; john.j.hentrich@bakernet.com 60

JOHN CANEPA, Arthur Andersen, 225 Franklin, Boston, MA 02110; 617-330-4000 60

BRUCE EMMELUTH, Van Kasper & Co., 10877 Wilshire Blvd., Suite 1700, Los Angeles, CA 90024; 310-209-2200 60

RENAISSANCE CAPITAL, 325 Greenwich Ave., Greenwich, CT 06830; 203-622-2978; www.ipo-fund.com 60

TOM STEPHENS, Tucker Anthony, 1300 I St. NW, Suite 450 E, Washington, DC 20005; 202-408-4510 60

Special Report: The Hottest Small-Company IPOs

  • The Secret World of IPOs - The new small companies in the public arena: the top aftermarket performers, the lawyers and underwriters they used, the hot industries. A guide to the action of the last year. By Robert A. Mamis.
  • You Don't Know Me... - How Robert Kopstein took his company public--on his own. By Robert A. Mamis.
  • So You Want to Go Public - What each of the exchanges demands from companies wanting to get on them. By Stephen D. Solomon.
  • Follow the Money - A dollar-by-dollar look at the cost of one company's IPO: why $7.2 million raised is $6 million earned. By Stephen D. Solomon.
  • Light Up. Go Public. Quit Your Day Job - The story behind Caribbean Cigar Co.'s public offering: "the cigar craze was getting huge," says the founder, and he needed money to keep up. By Jay Finegan.
  • FYI: Navigating the IPO Market - Background on the writers of the IPO package. By George Gendron.