Wednesday, July 27, 2005

Not Just a Payday: Why Firms IPO

Sadly, there are many people out there who seriously think firms IPO only to make themselves filthy rich.

While that can be the case (and has been several times over on the history of Wall Street), there is much more to the story than just self-enrichment.

One needs to look at it from the Creator's point of view.

First of all, an IPO is the apex of an entrepreneur's career.

As such, it should be taken seriously.

It's like that moment we all had as children building something in the garage.

Maybe it was your first tree house; maybe it was that 4th grade Science Project volcano.

When we finished building it, our first instinct was to summon our parents and show them the fruit of our labor.

That is essentially what an IPO is -- an opportunity to harvest everything you've sown and display it to the world at large for everyone to see.

But as much as an IPO seems to be an ending, it is really a beginning.

An IPO is a new chapter in a company's long life.

Serial entrepreneur Mark Cuban made this point a couple weeks ago when he said that the IPO for was followed (after a long night of celebratory drinking) by a serious, introspective undertanding of what it meant to be part of a public enterprise.

Sure, he was filthy rich.

But Cuban was now accountable to hundreds of thousands of shareholders.

I'm sure Cuban slept better before's IPO.

That is because when a company chooses to go public, it is also choosing ot share its wealth, prospects, and liabilities with mountains of people.

Public companies are visible to everyone, meaning they are prone to short term over-reactions whenever bad news hits the tape (whether or not it is true).

When Company XYZ fails, misses earnings, or is involved in a scandal, everyone points the finger at its CEO and management committee.

Such villification is usually followed by a sharp drop in market capitalization.

But that is the price they must all pay for entering the marketplace as a public entity.

Transparency for money.

An IPO raises the necessary money for companies to move along further in their trajectory.

And Wall Street is the only place to do it.

Without Wall Street, there'd be no Microsoft, no hope for a cure for cancer, no anything.

You think Bill Gates could have gone to a local bank in Washington and received the gargantuan loans he was able to accrue vis-a-vis the capital markets for his universal operating system?

I can imagine that conversation between Gates and his local bank rep.

"Hi _____, I'm Bill Gates and I'm working on a software application that'll be used by everyone across the globe -- how much do you think I can take out?"

While funding the future growth of a company is the primary reason firms IPO, other reasons abound.

IPOs enable a company to create stock that can one day be used to fund an acquistion.

Without stock, a company interested in taking out company B has to pay for it in cash.

Not always a viable option.

Finally, IPOs are the most logical "exit strategies" for partners who have been with the firm since its inception and would like to either partially or fully cash out on their investments.

This was clearly the case with Goldman Sach's IPO -- the firm saw a terrific opportunity in the maketplace (right at the market's peak before its crash in 2000) to raise money and multiply the net worth of its managers several times over.

Money simply gets transferred from the owners to all the investors waiting in line for a piece of the action.

As the Goldman example illustrates, timing is an integral part of the IPO equation.

There is more to an IPO than mere pocket-filling.

If executed properly, an IPO can be a winding road laden with opportunity.

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