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Tuesday, February 25, 2014

Some markets are impossible to control

Where did my bankers go after the IPO?
The JOBS Act of 2012 (JOBS = Jumpstart Our Business Startups), allows the Securities and Exchange Commission ("SEC") to treat documents required ahead of an IPO as confidential.  The process allows companies to shop for investors with no prior public awareness.  The law helps smaller companies work through issues prior to any IPO date. The process can be short for some companies and the ability to raise capital is important to advancement of the company. 

According to The Wall Street Journal, there were confidential IPO filings of more than 209 U.S. companies submitted to the SEC since Oct. 15, 2012. The companies averaged 74 days after the first confidential filing before issuing a public registration statement for their IPO. Companies with less than $1 billion in revenue in the prior fiscal year are considered emerging-growth companies under the JOBS Act and qualify for confidential treatment.

Investment banks manage the book for the IPOs and take the companies on road shows to attract interest.  Investors range from sophisticated investors in funds to retail investors that know little or nothing about the field the company works in.  The bankers try for a mix of retail and intuitional investors.  The split can be important, but more important is the follow up to create a market for the equity.

Some companies select a lesser known (and possibly lower quality) bank to pursue the capital raise.  Remember the movie “Boiler Room?” The amounts of the offerings can be in the $10s of millions and depending on the split of institutional investors to retail, the holders of equity post financing can range from few funds as investors to many independent individuals on a retail level. 

Investors may elect to hold on to the shares for long periods or seek exits quickly.  The issue is who makes a market in the stock and how much interest exists post IPO.  A hot equity can have great trading activity while a company with limited following may have only a few shares trading per day or even per week.  The latter creates significant problems.

Limited trading activity results in small orders and in frequent trades.  The lack of interest and limited trading may cause problems with your next capital raise.  Funds finding the company interesting may have volume and/or price restrictions.  The reasoning for the restrictions are seen in the following examples.  Suppose you own 1,000,000 shares in a company after an investment of $10,000,000.  Your holding period is usually a few years.  Now suppose the stock trades only 5,000 to 40,000 shares per week with extremes in price fluctuations.  If the stock moves up or down, the investor cannot get out without significant amounts of work.

A second issue arises as well.  Unsophisticated investors sometimes decide to get rid of a holding.  They may tell the broker to sell the stock.  With no counseling, the investor will sell at market rather than place a limit order.  A buyer may exist at a significant discount to market and the trade goes through with the investor taking a tremendous hair cut on the price.  The same is true in reverse.  Place an order at market and if the company trades in a limited manner, the price of the purchase may be at a very high premium.

The awareness and trading activity in the equity is an important issue for consideration by entrepreneurs.  When exploring the route to a financing, try to understand whether there will be any real support from the banking group(s) managing the offering after the offering is completed.  Secondly, create a program to generate and maintain awareness about the company and continue to follow up post financing.  Otherwise, you may find your company in a position that can create problems for your investors and possibly for your company.
  Taffy Williams is the author of:  Think Agile:  How Smart Entrepreneurs Adapt in Order to Succeed to via Amazon