By Neal McNamara and Chris Dussold, PhD
Initial Public Offering: the phrase itself induces images of potential wealth creation – both for the private shareholders pre-offering new owners post-offering. But IPOs serve multiple functions:
- raising capital to scale the business,
- providing a means for founders to exit and reward employees for their crucial roles in making an idea a commercial success; and
- providing an exit strategy for private equity and venture capital firms so that they can re-deploy capital.
With all that riding on an IPO, there is immense pressure to price the offering at maximum value. But markets ultimately decide the value of a public company. An IPO that declines significantly in its first days may have been priced too aggressively or may have just had the misfortune of coinciding with an overall dip in the market. Uber, Dropbox and Eventbrite are recent examples of IPOs that lost significant value for investors in their first days and weeks on a public stock exchange.
A smart pricing strategy positions the company at a generous valuation yet leaves room for growth to reward its public investors. Here are four variables affecting the pricing environment:
- Performance of Industry Peers – A close competitor going public prior to your planned offering should be closely watched.Quality returns for the rival’s first day, week and month can provide confidence in the market’s momentum and often a buzz in the media. But an underperforming rival offering erodes confidence in the sector that can bleed over into your company’s big day.
- Structure of Lockup Agreements – Markets are savvy to the impact of lockup agreement expirations among large insiders. Stock valuations tend to fall leading up to the known expirations of these agreements and the perceived loss of “buy-in” by significant insiders if they exercise their right to sell. It is important that filers communicate the continued important roles within the company these key players will have going forward, intending to create further value for shareholders. Lockup agreements need to be clearly articulated in the external corporate communications that will serve as the best mitigator of investor uncertainty around these dates. Facebook’s IPO had multiple lock up expirations. The first one allowed an additional 270 million shares to be available for sale. The stock quickly fell 6%. Two of its largest initial investors exited at that point. In all, Facebook had five different expiration periods, the largest of which allowed for 800 million additional available shares.
- Nature of Returns – It is an oxymoron of IPOs that the more money a company leaves on the table in first day/week/month returns, the more successful the offering is generally viewed. The firm and its underwriting syndicate need to strike a careful balance between the positive buzz created by out-sized returns and the additional capital that could have been raised with a more accurate pricing of the offering.
- Hot vs. Cold Markets – Equity markets have clear preferences when it comes to their appetites for IPOs. Returns of offerings are highly correlated with overall market performance. Companies need to weigh the benefits of waiting for a better market environment vs. raising capital for individual/corporate needs.
With the IPO market heating up in 2019 more owners/investors are considering the IPO route as their exit strategy.In addition to the intense preparation required to execute an IPO and operate as a publicly traded company (which is often underestimated), it is critical to understand the pricing environment and related strategies.