Initial Public Offering (IPO) Basics

Raising capital for your small business by going public

By Sheila Callahan, Freelance Journalist

When your small company needs to raise capital, SBA loans and angel investors aren't the only options. A growing number of small businesses are raising capital by issuing equity shares through an initial public offering (IPO). Going public means your shares will be traded on the stock market — for smaller firms, shares will most likely be traded on the Nasdaq SmallCap market or the Nasdaq National Market System. Going public isn't a decision to be made lightly, and there are a number of benefits and disadvantages.

Benefits of an IPO include:

Raising capital for your business.
Opening additional financial doors.
Granting prestige to your firm.
Making it possible to attract top talent by offering employee stock option plans.
Increasing the value of your business.

Disadvantages of an IPO include:

The process is extremely expensive, time-consuming and challenging.
You're saddled with obligations to keep shareholders informed.
You and your company can be held liable for any non-compliance.
You lose some control of your company when shareholders must approve your actions.

Determine your capital needs

IPOs are best for firms that want to raise at least $5 million. Most smaller firms look to raise between $5 and $15 million.
Try: Use the business calculators at Dinkytown.com to help you assess how much capital you need to raise.

Establish growth potential

To be considered a good candidate for an IPO, start-ups and existing smaller businesses must demonstrate significant future growth potential — usually a minimum of 20 percent in earnings growth per year. Companies should be on target to reach a valuation of at least $100 million for a successful IPO.
Try: ForecastPro is a software program that can help you chart your growth potential.

Understand the costs

An IPO is one of the most costly and challenging methods of financing your operation. Expect to give up approximately 25 percent of your firm's equity and be prepared for fees and expenses to mount as high as 25 percent of the capital raised.
Try: IPOVitalSigns.com offers tips on how to evaluate and control the costs of going public.

Strengthen your management team

One of the main things underwriters look for is an experienced management team. Shore up your management team by hiring top-notch executives with a strong reputation in the industry.
Try: Post jobs at TheLadders.com, which specializes in helping companies find top talent.

Find an investment banker

Look for small investment banking firms that have experience managing IPOs of smaller businesses. Any firm you consider should be handling at least four IPOs per year.
Try: Check out IPOMonitor.com or IPO Central at Hoovers.com to find underwriters who are handling the IPOs of smaller companies.

Hire an accountant or attorney

Many investment banks won't even look at your business plan unless they have a personal relationship with your business or with someone representing your business, such as an accountant or attorney. Hire an accounting firm or an attorney with recent experience handling IPOs. This may help you get a referral.
Try: Search for accountants who specialize in SEC/securities at AccountantsWorld.com and search for securities attorneys at FindLaw.com.

Consider hiring a consulting firm

Navigating the complex issues surrounding an IPO can be difficult and time-consuming for busy business owners. Several consulting firms have emerged to help businesses develop and implement an IPO plan.
Try: Shop for IPO consulting firms, such as Nagle & Ferri, which provides complete pre- and post-IPO programs.

File a registration statement

You must file a registration statement with the SEC in order to make a public offering. There are two main parts to a registration statement: Part I must include descriptions of the business operations, financial condition and management; Part II is additional information. This vital form should read like a sales brochure.
Try: Smaller businesses can use one of two simplified registration forms Form SB-1 to raise up to $10 million or Form SB-2 to raise any amount.

Do a road show

Once your registration statement has been accepted, you and your management team must do a "road show". Basically, your team travels nationwide presenting your company to stock brokers who will sell it to their public investors.
Try: Sharpen your presentation skills by participating in training classes and seminars from the Leaders Institute.

Make sure your financials are in order. If underwriters determine that aggressive accounting methods are the only reason your balance sheet is showing a profit, your deal will die.
Underwriters will either underwrite the IPO on a "firm commitment" or "best efforts" basis. In the former, the underwriters purchase shares at a discount (generally 7 percent) then sell them to institutional and retail clients at full price. The second option only commits the underwriters to do their best to place the offering, with no guarantee to your company.
Timing is everything in an IPO. Being flexible and able to take advantage of market ups and downs is another critical factor.