Success Factors of Primary Issuances

IPOs are amongst the most challenging investment banking transactions to execute. This is partly because the nature of IPOs involves a large reliance on the reaction of public markets to the stock being offered – something that is difficult to gauge beforehand. Unlike the dot-com bubble days, today’s VC-backed companies have to wait a duration of 7-10 years before they are ready to pitch themselves to the public markets and raise capital from public investors. Post the bubble, investors have become a lot more cautious about past performance and require steadier cash flows while relying less on “creative metrics” used in the bubble days to justify low or negative earnings. In this environment, there are some factors that companies can consider before initiating the IPO process.

Firstly, it is important to have a C-Suite (particularly the CEO and CFO) that is well-versed with the paradigm shifts of equity capital markets (ECM) and Wall Street. The CFO has the greatest visibility when marketing the IPO and is a crucial component after the IPO as the company adjusts to public demands from functions such as investor relations. It is also important to select the right investment banking syndicate that can deliver the best performance for your IPO. While most ECM assignments these days have a “bake-off” where rival banks pitch their offering to the company and advertise themselves as the most capable player, it is important to conduct some research yourself before selecting the syndicate. Not only would this make the bake-off less make or break, it also grants you leverage when negotiating investment banking fees with the banks if you have built up a strong working relationship. Further to that point, having reputable analysts covering your company adds a feather to the cap when marketing an IPO. Once again, this is a reason to conduct your own research on the best banking syndicate to execute your deal. While the importance of sell-side research has declined in value, there are still compelling reasons to have knowledgeable analysts covering your stock, particularly if you anticipate yourself using other investment banking services from the same bank.

An upcoming primary issuance is also a tool to attract new Board members and talent to your company. Although providing stock options is difficult once an IPO is done since the options would then be priced in line with the market, the IPO itself is a powerful resource when attracting new talent to the company. It also helps to increase operating expenditures on the balance sheet which then translates into lower expectations on Wall Street for the initial quarter. Further to this point, the best managed firms on Wall Street are those that have learned to straddle performance with managing expectations. It is not uncommon for companies to reduce their model outputs by up to 20% in the days leading up to an IPO in order to lower investor expectations and prevent a decline in stock price once trading starts. A lower base allows for the target to be beat with a little more comfort, thus causing the stock to appreciate. Human nature dictates that we react to bad news with more gravity than good news. Therefore, an earnings miss versus its estimates would be more detrimental for the stock price than an earnings beat would be beneficial.

Lastly, it is important to have a balance sheet with good existing liquidity even before the IPO starts trading. While the main point of an IPO is to raise capital to manage liquidity and expansion, having an adequate position prior to the IPO would give investors a lot more confidence when investing in the company. Beginning the IPO in a position of strength allows for investors to make more assured, informed decisions that would ultimately work in the company’s favour. As a side note, one final tip that companies would do well to heed would be to not conceptualize any “creative metrics” in the IPO. When companies attempt to do this, it gives investors cause to believe that there may be something that the company is seeking to brush under the carpet, which therefore plays negatively in the price of the stock.